The unusual suspects: are well-meaning environmental stakeholders and institutions undercutting the contributions that companies can make to fighting climate change?

Abstract

There is broad consensus that a significant majority of the capital needed to fund a low carbon transition consistent with science-based decarbonization timelines will have to come from the private sector. While still inadequate, the past decade-plus has seen a nonlinear increase in corporate capital spend in pursuit of voluntary climate goals. In the absence of significant regulatory mandates or meaningful carbon pricing, how this ‘corporate climate spend’ is directed is influenced—if not largely directed—by an array of emissions accounting rules, third-party defined leadership metrics and methodologies. This ‘rules and reward ecosystem’ is largely the design of environmental advocates, academics, and other aligned stakeholders and philanthropists. Sitting at the heart of this ecosystem is the Greenhouse Gas Protocol—a purported accounting framework that underpins how companies can undertake climate-based interventions and record progress. Launched by environmental stakeholders in 1998, the Protocol has since become the de facto rulebook used by highly influential third-party corporate leadership and target setting organizations, sustainability rating and evaluation entities serving the investment community, and is being incorporated into emerging mandatory corporate disclosure programs. Ironically, given its architects, today the rules and reward ecosystem results in significant mis-allocations and constraints on corporate climate spend and is reducing the potential climate change-mitigating impact of crucial private capital. This paper explores the flaws in incumbent greenhouse gas accounting and leadership program rules and proposes pathways for change that would better optimize the flow of private capital available and needed to address the climate crisis.

Climate change, Greenhouse Gas Protocol, Scope 2, Scope 3, emissions, carbon accounting, clean energy, supply chain decarbonization, science-based targets

Introduction

Over the past two decades, a steadily increasing number of corporations around the world have adopted some level of commitment to address climate change and at the same time, the ambition of company commitments has increased. The reasons for these trends vary. Some may feel pressured to keep up with competitors while others may see taking climate action as a strategic public relations opportunity. More and more companies, however, are finding that adopting and executing on climate commitments can lead to a host of value creation opportunities, including cost savings, risk mitigation, innovation opportunities, talent attraction and retention, stronger brand loyalty, and increased shareholder value. Regardless of the reasons, the relationship between the corporate world and climate change has changed. The private sector is positioned as never before to contribute to the challenge of decarbonization through voluntary actions.

While this is good news from a climate perspective, it is becoming increasingly clear that the actual impact that these companies might make in pursuit of their climate ambitions is being held back in some very unlikely ways. When a company does undertake voluntary climate measures, it is guided by an array of emissions accounting rules, stakeholder guidelines, third-party defined success metrics, and evaluation methodologies that shape its decisions and investments. While well-intentioned and responsible for much progress, this ‘rules-and-rewards ecosystem’, designed and administered by environmental nongovernmental organizations and their allies, may no longer be fit to the task of guiding company actions in a way that optimizes benefit to the climate. Two decades on from its inception, the rules-and-rewards ecosystem is due for some much-needed modernization.

Voluntary private sector actions are essential in driving decarbonization

Public sector investments are an indispensable part of meeting the challenge of decarbonizing the global economy and stabilizing global temperature increases at 2°C or less.

In 2022, the United States Congress committed an unprecedented 10-year federal investment of approximately $40 billion per year to combat climate change. Yet, according to a recent McKinsey & Company report, the world will need to invest more than $9 trillion per year for the next 30 years to reach mid-century climate goals [1]. The International Renewable Energy Agency (IRENA) estimates that energy transition technologies will need investments of around $131 trillion by 2050, about 80% of which is expected to come from the private sector [2].

In 2022, the United States Congress committed an unprecedented 10-year federal investment of approximately $40 billion per year to combat climate change. Yet, according to a recent McKinsey & Company report the world will need to invest more than $9 trillion per year for the next 30 years to reach mid-century climate goals.

While these numbers are daunting, there is a clear and welcome trend underway: More and more companies are setting voluntary climate goals and spending money to meet them. Today, 82% of the global Fortune 500 have announced climate-related targets [3]. The type and aggressiveness of these commitments vary as do the reasons for making them. Some do so grudgingly just to keep up with competitors or to satisfy some of their shareholders; some see climate action as part of being a good corporate citizen; others see opportunities for risk reduction and value creation; or it may be some combination of all of these (and, of course, there are a number—albeit a shrinking number—of companies taking no real actions at all). Regardless of why, over the past decade plus, more and more corporate resources are being dedicated to climate change mitigation. Such measures may include investments in energy efficiency, decarbonizing on-site energy production, procurement of cleaner energy and lower carbon inputs from third parties, investments in research and development for lower carbon technologies, or developing and offering more climate friendly goods and services to the market.

While these numbers are daunting, there is a clear and welcome trend underway: More and more companies are setting voluntary climate goals and spending money to meet them. Today, 82% of the global Fortune 500 have announced climate-related targets.

While allocating human and financial capital to climate goals has become common practice among large companies, corporate climate spending is not a limitless resource. Like any other decision about commitments of human resources and capital, companies face competing priorities and must assess the ‘returns’ on each potential climate-related investment. While some climate-related spends yield positive returns on investment on a purely economic basis (think switching from fluorescent to LED lighting), other investments may only make sense when considering other advantages, such as ‘paybacks’ to reputation, investor relations, employee retention, or customer loyalty.

Corporate climate decision-making is influenced by a complex ‘rules-and-Rewards ecosystem’

Companies themselves are not scientific institutions or environmental advocacy groups. To understand what goals to set, what actions to take, and which goals and actions will be considered adequate and appropriate leadership by both internal and external stakeholders, companies look elsewhere for guidance. Over the past two decades, a complex rules-and-rewards ecosystem has developed to guide and incentivize corporate climate investment. This array of emissions accounting, disclosure, and recognition programs provides a common set of metrics, goal-setting standards, and leadership-recognition criteria that guide company decision-making, enabling myriad stakeholders to benchmark and assess performance.

Companies themselves are not scientific institutions or environmental advocacy groups. To understand what goals to set, what actions to take, and to determine what goals and actions will be considered by both internal and external stakeholders as adequate and appropriate leadership, companies look elsewhere for guidance.

Elements of the ecosystem

The greenhouse gas protocol

Sitting at the foundation of the rules-and-rewards ecosystem is the Greenhouse Gas Protocol (the Protocol) [4], an accounting framework that underpins how companies can undertake climate-based interventions and record progress. Launched in 1998 as a joint initiative of the World Resources Institute and the World Business Council for Sustainable Development, the Protocol sought to develop and promote a system of best practices for voluntary accounting and reporting of greenhouse gas (GHG) emissions. In 2001, the Protocol published the first version of its ‘Corporate Standard’ by which companies could create GHG ‘inventories’ of the emissions attributed to their activities [5].

Two decades ago, when the Protocol was created, there was a pervasive (and not unjustified) view that the private sector was a reluctant (if not adversarial) partner in meeting the challenge of climate change. Because enacting proscriptive regulation to force GHG emissions reductions was not politically viable, another option was to ask companies to account for and publicly disclose their emissions, with the expectation that this in turn would incentivize them to reduce emissions.

The Protocol serves as the ‘rulebook’ for the vast majority of voluntary GHG reporting and recognition programs across the globe. The Protocol also forms the basis for mandatory corporate reporting programs in effect in the UK, coming into effect in the EU and will likely form the basis of mandatory reporting requirements expected from the U.S. Securities and Exchange Commission.

Under the Protocol, a company’s GHG inventory is broken into three components (or ‘scopes’): Scope 1 includes direct emissions from a company’s operations and assets (such as emissions from company-owned vehicles or from burning fuel in an on-site boiler); Scope 2 includes indirect emissions from purchased energy (e.g. emissions at the power plant that generates the electricity that a company buys from its utility); and Scope 3, which are emissions not controlled by the company but are in its ‘value chain’ (e.g. emissions created by suppliers producing goods and services used by the company in conducting its business).

The Protocol serves as the rulebook for the vast majority of voluntary GHG reporting and recognition programs across the globe and as such has a major impact on voluntary climate strategies and interventions. But the Protocol also forms the basis for mandatory corporate reporting programs in effect in the UK and those coming into effect in the EU; it is also likely to be the recommended format for mandatory reporting requirements expected from the US Securities and Exchange Commission [6–8]. The Protocol is essentially evolving into an actual regulatory construct.

Third-party disclosure and leadership programs

As hoped for when the Protocol was developed, companies that calculate and disclose their emission inventories often set public goals to reduce or otherwise mitigate them. Increasingly, company goals are set in line with the terms and requirements of third-party leadership programs, each of which largely bases measurement and disclosure on the Protocol. A few key programs include:

• CDP (formerly known as the Carbon Disclosure Project), a nongovernmental organization that runs the most widely used platform in the world for companies to disclose their GHG emissions (calculated pursuant to the Protocol).

• RE100, an NGO-sponsored initiative through which companies pledge to match 100% of their electricity use with renewable energy by 2050 or sooner and to disclose their progress.

• Green Power Partnership (EPA GPP), the U.S. Environmental Protection Agency’s voluntary rewards-and-reputation program, where companies pledge to procure a minimum amount of new renewable energy based on their size.

• Science-Based Targets Initiative (SBTi), an NGO-organized program that ‘mobilizes the private sector to take urgent climate action’ by ‘guiding companies in science-based target setting’ (i.e. emissions reduction targets that SBTi determines to be ‘in line with what the latest climate science deems necessary to meet the goals of the Paris Agreement—limiting global warming to 1.5⁰C above preindustrial levels’.) SBTi instructs companies to base their targets on Scopes 1, 2, and 3 of the Protocol and to report to SBTi progress towards meeting those targets through annual disclosure of their inventories.

The ecosystem strongly influences corporate decision-making and ‘climate spend’

Today, nearly three-quarters of S&P 500 companies voluntarily calculate and disclose their GHG emissions, mostly through CDP [9]. RE100 boasts nearly 400 member companies with 100% renewable electricity goals. SBTi has grown from 1000 companies that committed in 2020 to more than 4000 at the end of 2022. Companies with approved or pending-approval SBTi commitments represent over a third of the global economy’s market capitalization, and 96% of companies with approved SBTs have targets covering Scope 3 emissions [10, 11].

Though voluntary themselves, the rules of the Protocol and of various disclosure and goal- setting programs (like CDP, RE100, and SBTi) have evolved into a quasi-regulatory system that shapes climate decision-making for a vast and growing number of companies adopting climate strategies. How a company reports and tracks progress under these rules has become the basis upon which it is assessed by the media, climate advocates, sustainability-minded investors, employees, and other stakeholders.¹ Yet, while these ecosystem rules essentially have the power of regulation, they lack the governance structures and procedural safeguards of governmental regulatory requirements, such as transparency, participatory guarantees, or rights to appeal decisions.

Though voluntary themselves, the rules of the Protocol and of various disclosure and goal setting programs like CDP, RE100, and SBTi have become a quasi-regulatory system that shapes the climate decision making of the vast and growing number of companies adopting climate strategies. How companies report and track progress under these rules have become the basis upon which companies are assessed by the media, climate advocates, sustainability-minded investors, employees, and other stakeholders.

The current ecosystem undercuts the potential climate benefits of company interventions

Does the original foundational theory of the protocol still make sense today?

The Greenhouse Gas Protocol’s approach to corporate GHG accounting was built around a foundational theory of change: By attributing emissions to a company through the creation of inventories, and then exposing those inventories to the light of day, companies would feel pressure to reduce their calculated and reported emissions (attribution → inventories → disclosure = impact). For a number of reasons, however, it is appropriate to ask whether this ‘attributional’ approach to GHG accounting is adequate and appropriate two decades on.

When this rules-and-rewards ecosystem was created, the vast majority of companies needed to be pressured and coaxed into taking proactive steps to reduce emissions. And while the ecosystem has led more and more companies to calculate and disclose their emissions inventories, it is not at all clear if this remains an optimal approach. Inventories are tools and by themselves have no climate value (the climate does not care which emissions are in whose inventory). The right question today is whether these rules yield the most beneficial climate impact. We must reassess the current ecosystem if for no other reason than because the world remains dangerously behind in making the decarbonization progress called for by science.

When this system was created, the vast majority of companies neededto be pressured and coaxed into taking proactive steps to reduce emissions. Today, many more companies are willing partners in the effort to address climate change.

Unfortunately, despite its achievements, the current rules-and-rewards ecosystem is significantly flawed and out of step with both climate science and the ability of today’s leading companies to contribute to addressing the climate crisis.

Despite its achievements, the current rules-and-rewards ecosystem is significantly flawed and out of step with both climate science and the ability of today’s leading companies to contribute to addressing the climate crisis.

The ecosystem’s approach to Scope 2 emissions undercuts its own theory of change

The idea that real climate impact will flow from creating and disclosing an emissions inventory only holds true if: (i) the inventory itself is an accurate reflection of actual emissions; and (ii) if subsequent interventions to reduce that inventory reflect actual climate benefit. For the rules governing the accounting of emissions from purchased electricity, neither is necessarily true.

Scope 2 accounting rules do not accurately reflect company emissions

Scope 2 inventories are intended to be ‘a true and fair account of [a company’s] emissions’ from purchased and consumed electricity [12]. But the electricity a company uses at any given location or time comes from the mix of generation sources purchased from its local utility or retail electricity supplier. In any given hour, that electricity might come from coal, gas, nuclear, or renewables. There are ways a company can impact the generation mix it buys and uses, such as installing solar panels on its buildings or contracting directly with a nearby renewable energy facility. Such interventions would and should result in a decrease in attributed emissions from electricity use.

Under the Scope 2 ‘market-based’ accounting rules [13], however, it is perfectly appropriate for a company to report reduced emissions from their electricity use even if it has not changed its actual use in any way. A company can purchase instruments known as energy attribute certificates (EACs)—or, in the USA, renewable energy certificates (RECs)—alongside, and in addition to, electrons generated at a renewable energy generation facility. The idea behind EACs/RECs is that there is value in renewable generation beyond the electrons it produces and sells; its lack of emissions or inherent ‘renewableness’ also has value. Therefore, since renewable generators are producing two things of apparent value, they should be able to get paid for both; creating and selling certificates allows them to do that.

Under the Scope 2 ‘market-based’ accounting rules, it is perfectly appropriate for a company to report reduced emissions from its electricity use even if it has not changed its actual use in any way.

Further, because electrons cannot be physically differentiated once they enter the grid, EACs and RECs provide a way to track and transact for the differentiated value of renewable generation. It is this function that the Protocol seized upon in designing its Scope 2 inventory accounting rules. Companies are instructed that each EAC or REC they own can be used to ‘erase’ from its inventory the actual emissions associated with any megawatt hour of its electricity use within a given year.²

But this allowance undercuts the proposition that the resulting inventory represents ‘a true and fair account’ of emissions from electricity use. A company might be located in Indiana, where over the course of a year the majority of the electricity it consumes comes from coal and gas. But if the company buys enough RECs from wind farms in Texas to match its yearly consumption, it can report an inventory showing zero emissions from its electricity use—even though those wind farms are on an entirely different grid and had no impact on the emissions from the electricity the company actually used in Indiana that year.

When the rules were written, there were justifications for sacrificing the goal of Scope 2 inventories as being a ‘true and fair’ account of emissions from electricity use. At that time, wind and solar were sparsely deployed and expensive relative to fossil energy; it was thought that creating demand for certificates would encourage construction of more wind and solar capacity and thus help the renewable industry to scale and drive down costs. Further, because of legal and market constraints in many jurisdictions, many companies could not put solar on their roof or contract for renewable energy from their electricity provider. Allowing companies to reduce their inventories simply by purchasing EACs was an alternative way for them to invest in clean energy.

This approach worked very well. Today, wind and solar are relatively mature, widely deployed, and cost-competitive technologies. Yet, while a lot more wind and solar need to be deployed in many places, and while direct clean energy procurement options for companies remain very limited in some places, it is not clear that the way Scope 2 accounting utilizes certificates remains the right approach.

A reduction in a Scope 2 inventory may not equate to any actual Real-World emissions reduction

Unlike today, at the time certificate-based accounting rules were developed, wind and solar technologies were sparsely deployed and there was near-certainty that installing new renewable capacity virtually anywhere would displace fossil generation. Simply giving ‘credit’ for renewable energy capacity was a pretty good proxy for giving credit for actual emissions impact. Today, however, it is increasingly clear that legacy certificate-based Scope 2 accounting severs the links of ‘attribution → inventories → disclosure = impact’.

There is no requirement under Scope 2 accounting rules or third-party leadership programs for a company to show or even evaluate whether a reported decrease in a Scope 2 emissions inventory resulting from a procurement transaction reflects an actual decrease in real-world emissions. And it may be that the reported inventory reduction does not at all correspond to actual emissions reductions. For example, if the RECs used to reduce an inventory come from a new wind farm in West Texas, those MWhs reflected by the RECs likely had very little incremental climate benefit in that wind-saturated region where new renewable generation likely displaces a lot of existing renewable generation. On the other hand, a new wind farm in fossil energy-saturated West Virginia is likely to directly displace coal or gas generation. Yet the RECs from both projects have the same impact on a company’s Scope 2 inventory, despite having very different climate impacts, and will be equally reported—and rewarded—as ‘emissions reductions’ in the company’s inventory. The accounting and leadership rules provide no incentive or reward for a company to create more climate impact by choosing to procure clean energy from a region of higher grid carbon intensity.

There is no requirement under Scope 2 accounting rules or the third-party leadership programs for a company to show or even evaluate whether a reported decrease in a Scope 2 emissions inventory resulting from a procurement transaction reflects an actual decrease in real world emissions. And it may be that the reported inventory reduction does not at all correspond to actual emissions reductions.

The questionable construct of Scope 3

Scope 1 emissions are straightforward: If a company owns a truck, the emissions from that truck are controlled and ‘owned’ by the company. While Scope 2 emissions are indirect and depend on how the electricity purchased and used by a company was generated, companies do have some control over those emissions through supply choices and efficiency measures.

‘Scope 3’ emissions are defined by the Protocol as ‘all indirect emissions (not included in Scope 2) that occur in the value chain of the reporting company’ [14]. If you are a retailer, for example, all the products you sell were manufactured by someone else who created emissions in that process, and that manufacturer in turn had its own supply chain with someone else’s emissions, and so forth. Scope 3 emissions are not directly controlled by a company, and the company typically does not have a clear sightline to all of those emissions. But they are often the largest part of a company’s emissions ‘footprint’. Various estimates show that Scope 3 emissions typically range from 65 to 95% of a company’s total across the three Scopes [15].

Why was Scope 3 created? All of a company’s Scope 3 emissions are someone else’s Scope 1 and Scope 2 emissions, but the architects of the ecosystem knew that the number of companies that would sign up for voluntary emissions attribution and disclosure would be limited. And because basing the entire accounting system on the construct of attribution → inventories → disclosure = impact only works if companies agree to have their emissions attributed to them, adding the emissions of other nonparticipating entities’ Scope 1 and Scope 2 emissions to what participating companies would be asked to account for—and then, hopefully, act to reduce—was essentially a ‘work-around’ to get at some of those nonparticipant emissions.

Why was Scope 3 created? All of a company’s Scope 3 emissions are someone else’s Scope 1 and Scope 2 emissions, but the architects of the ecosystem knew that the number of companies that would sign up for voluntary emissions attribution and disclosure would be limited. And because basing the entire accounting system on the construct of attribution → inventories → disclosure = impact only works if companies agree to have their emissions attributed to them, adding the emissions of other non-participating entities’ Scope 1 and Scope 2 emissions to what participating companies would be asked to account for—and then, hopefully, act to reduce—was essentially a ‘work-around’ to get at some of those non-participant emissions.

In some ways the approach has worked, as Scope 3 reduction commitments are becoming commonplace; 96% of companies with a science-based target approved by SBTi have targets covering Scope 3 [16]. But it is fair to question the effectiveness of this dramatic extension of the attributional theory of change. The climate-critical question is whether the current inventory-first approach to Scope 3 emissions best sets up a company for the final and climate-imperative step of having decarbonization impact. It may not.

For example, extending the attributional theory of change to Scope 3 has proven ineffective because of a flawed assumption made at the time it was created: that the data needed for attribution and creation of an inventory could be found. Accenture estimates that nearly two-thirds of a company’s supply chain emissions come from suppliers the company does not deal with directly, and many companies do not even know all of their suppliers except those with whom they have a direct contractual relationship (referred to as ‘Tier One’ suppliers) [17]. This inventory problem makes getting actual emissions data very difficult, even if all suppliers calculate their own emissions, which they do not. Companies are instructed by the Protocol to engage Tier One suppliers under the assumption that they have the most leverage with these suppliers and might be able to get real data from them [18]. But even if that outreach does yield data, it is often incomplete, unverified, and not standardized.

When it became clear that completing a Scope 3 inventory with actual emissions data was not possible, instead of rethinking their doctrinal view that interventions for impact would and should come only after attribution and the creation of inventories, the Protocol and its reliant third-party programs doubled down. The Protocol’s Scope 3 guidance allows companies to ‘use secondary data to fill data gaps’ in the inventory, including tools and methods by which they can make ‘rough approximation[s]’ of their Scope 3 emissions using estimates, modeling, industry averages, average emissions factors, or generic life-cycle assessments to complete their ‘full Scope 3 footprint’ [18, 19].

When it became clear that completing a Scope 3 inventory with actual emissions data was not possible, instead of rethinking their doctrinal view that interventions for impact would and should come only after attribution and the creation of inventories, the Protocol and its reliant third-party programs doubled down.

While gathering actual information on emissions from suppliers, for example, can be burdensome, it may be worth the effort. Such real data might allow a company to compare suppliers of comparable inputs and factor those emissions into their supplier choices. Or a company might share best practices and insights to help a supplier set its own targets and make changes to reduce the supplier’s identified emissions. Perhaps more importantly, identifying actual emissions in a value chain can provide the basis for a host of interventions to achieve impact—if a company is incentivized and empowered to execute those interventions (more on this later).

On the other hand, allocating valuable climate budget to modeling, generic data gathering, and other inventory-building workarounds that yield only ‘rough approximations’ of actual emissions may not be worth it. The test—as for all aspects of the rules-and-rewards ecosystem—should be whether steps companies are asked to take best lead to decarbonization impact. Generic or modeled data using emissions proxies based on referenced data not directly applicable to a given supplier, however, does not provide information on actual emissions sources that might then be the focus of an intervention in a company’s supply chain.

Although assembling a ‘complete’ Scope 3 inventory drains employee bandwidth and budgets for climate initiatives, and so much of the data companies are asked to assemble is unactionable, completing a Scope 3 inventory is what companies are instructed to do. Once a Scope 3 inventory is completed, targets are set and progress is assessed by subsequent changes in that inventory—changes that might only be reflected by changes in proxy, generic, or modeled data. For that reason, the Protocol acknowledges that ‘[c]hanges in a company’s [Scope 3] inventory over time may not always correspond to actual changes in GHG emissions to the atmosphere, since there is not always a direct cause-and-effect relationship between the reporting company’s activities and the resulting GHG emissions’ [20].

When a Scope 3 inventory is complete, targets are set and progress is assessed by subsequent changes in that inventory—changes that might only be reflected by changes in proxy, generic, or modeled data. For that reason, the Protocol acknowledges that ‘[c]hanges in a company’s [Scope 3] inventory over time may not always correspond to actual changes in GHG emissions to the atmosphere, since there is not always a direct cause-and-effect relationship between the reporting company’s activities and the resulting GHG emissions’.

Asking companies to undertake significant effort and expense in assembling inventories with unactionable data, and then taking actions to reduce their inventories that may or may not correspond to actual emissions reductions, is one way the rules-and-rewards ecosystem has tied itself in knots—and undercut climate impact—as it stubbornly insists on extending its attributional theory of change to Scope 3.³ But there are other problems.

Suppose a company, based on actual emissions data, identifies a source of emissions in its supply chain that might be reduced by an intervention (say by replacing gas boilers with electric heat pumps) and considers financing such a project at a supplier’s facility. Despite being a clear and direct opportunity to reduce actual emissions, the company will find that the rules-and-rewards ecosystem presents significant headwinds to such an intervention. First, the Protocol maintains that ‘[a] complete GHG inventory across scope 1, scope 2, and scope 3 is needed to enable companies to understand and manage climate related impacts, risks and opportunities’ [20]. This statement is demonstrably false if the company identified an emissions reduction opportunity before ‘completing’ its entire Scope 3 inventory. Under SBTi’s rules, a company cannot get a science-based target approved without first completing a full Scope 3 inventory. But if the company identifies an emissions reduction opportunity before completing its inventory or getting its science-based target approved, it might well hesitate.

However, even if the company has completed its inventory and has an approved ‘science-based target’, it will find more barriers to investing to reduce those emissions. In the example above, suppose that replacing a supplier’s boiler results in 100 tons of emissions reductions. Under attributional/inventory-based accounting and crediting, those are considered Scope 1 and/or Scope 2 emissions reductions for the supplier. For the company that finances the project, those reductions only proportionally reduce its Scope 3 inventory. If the company accounts for 25% of the supplier’s sales, it would only see a 25-ton reduction in its Scope 3 inventory; the rest of the reduction would go to the Scope 3 inventories of other customers of the supplier who did nothing to make the project happen. It is unlikely that the company’s CFO will agree to fund the project for such a meager inventory reduction ‘return,’ and those emissions may remain unabated. This result seems not only suboptimal from a climate perspective but also unfair: if a company pays for the project, it might rightly expect to get credit for the resulting emissions reductions.

Under SBTi’s rules, a company cannot get a science-based target approved without first completing a full Scope 3 inventory. But if the company identifies the emissions reduction project opportunity before completing its inventory or getting its science-based target approved, it might well hesitate. Even if the company has completed its inventory and has an approved ‘science-based target,’ it will find more barriers to investing to reduce those emissions.

The current ecosystem’s discouragement of a company investing in these types of emissions reductions stems not only from how the attributional accounting system metes out limited credit to that company’s Scope 3 inventory. Project-level interventions to reduce or avoid emissions in a company’s value chain are discouraged even more.

[A]mbiguity from SBTi discourages companies from spending the time to find, vet, and underwrite high-impact emissions-abatement projects solely because they fall outside of their direct supply chain.

Suppose a company identifies an emissions reduction project it might be willing to pay for that is located at one of its supplier’s facilities (again, e.g. replacing a gas boiler with an electric heat pump). The Protocol would say that any resulting emissions reductions could only be reported outside of the company’s inventories. For SBTi, that emissions reduction project would likely be deemed an ‘inset’ project and might not extend any credit from the project towards a company’s science-based target. SBTi’s current position is that it will ‘assess insetting on a case-by-case basis … and may not approve their use’ [21]. Because its inventory is not reduced and the project would not further the company’s effort to meet its science-based target, it will be difficult to get the investment approved. This ambiguity from SBTi discourages companies from spending the time to find, vet, and underwrite high-impact emissions-abatement projects solely because they fall outside of their direct supply chain.

A ton is a ton—wherever it may be and however the intervention is done

It is axiomatic in climate science that a ton of GHGs reduced, avoided, or removed has the same climate value regardless of where that action occurred, who was responsible for the intervention, or whose emissions were impacted. The rules-and-rewards ecosystem, however, has a clear ‘hierarchy’ for emissions-impacting interventions: Companies should first direct climate spend to reducing emissions in their operations (Scopes 1 and 2) and then address emissions in their value chain (Scope 3). Directing corporate climate spend to emissions reductions outside of inventories is at best not incentivized and often discouraged—irrespective of the fundamental climate science that a ton is a ton. This hierarchy is again the result of the theory of change that attribution → inventories → disclosure = impact. But does this quasi-regulatory hierarchy get the most decarbonization impact from the significant—but finite—amount of corporate climate investment?

It is axiomatic in climate science that a ton of GHGs reduced, avoided, or removed has the same climate value regardless of where that action occurred, who was responsible for the intervention, or whose emissions were impacted. The rules-and-rewards ecosystem, however, has a clear ‘hierarchy’ for emissions-impacting interventions: Companies should first direct climate spend to reducing emissions in their operations (Scope 1 and 2) and then address emissions in their value chain (Scope 3).

That may not be the case if a given amount of corporate climate investment directed at an opportunity inside that company’s inventory would yield less decarbonization benefit than if that same amount of investment is made outside its inventory. For example, a company might replace a 5-year old HVAC system at one of its facilities with a slightly more efficient and more airtight system, thus getting inventory reductions in Scope 1 (less refrigerant leakage) and Scope 2 (less electricity needed to power the system). This approach would rightly be encouraged and rewarded under current disclosure and target-setting programs. If, on the other hand, for the same amount of money the company was willing to finance the replacement of a 15-year-old very leaky and highly inefficient HVAC system at somebody’s else’s facility unrelated to the company (which would result in even more climate benefit), the decarbonization benefit would be assessed very differently.

Such a project would be deemed an ‘offset’ (or ‘carbon credit’)—a market-based tool by which a company seeks to claim emissions reductions from an intervention. But offsets are categorically disallowed as a tool to meet an SBTi target, and the Protocol only allows the reporting of project-level emissions reductions outside a company’s inventory. This is the case even if the offset project meets all tests regarding the accuracy of emissions impact measurement, avoidance of ‘double counting’ of the emissions impact by more than one entity, and proof that those emissions reductions would not have happened but for the company’s intervention. By not ‘crediting’ these types of interventions, the Protocol and SBTi disincentivize even interventions that result in significant climate impact per dollar of corporate investment.

When the rules and rewards were designed, the idea of a company proactively looking to spend money in pursuit of the most decarbonization impact from that spend was perhaps not contemplated, since companies were seen as the problem and not potential partners in solving the climate challenge. While the legacy, inventory-focused model may still be the best way to get decarbonization effort from some companies, others are now looking to increase the decarbonization impact from their climate spend—and the system should also be designed to fully encourage and reward them. The fealty of the rules-and-rewards ecosystem to inventories over impact, and its bias against the use of market-based interventions, can lead to highly inefficient use of corporate budgets and suboptimal climate outcomes.

The rules-and-rewards ecosystem can be improved to increase the private sector’s contributions to decarbonization

Some argue that we should be hesitant to make any major changes to the Protocol, because it forms the basis for both voluntary and mandatory accounting and disclosure practices around the world. But this is precisely why improving and modernizing the Protocol is so important.

First: prioritize impact over process

All process steps dictated by GHG accounting and the various leadership programs should be evaluated against the principle of getting the most decarbonization impact from corporate climate investment.

The organizing principle of achieving impact through the process of attributing emissions, creating inventories, and disclosing that information should be scrutinized. All process steps dictated by greenhouse gas accounting and the various leadership programs should be evaluated against the principle of getting the most decarbonization impact from corporate climate investment.

Calculating inventories based on the Protocol and responding to the multitude of disclosure and leadership programs that seek and rely on inventory information are very time and budget intensive, consuming significant company resources. A recent ERM survey of companies across sectors found that an average of $533 000 per year per company was spent on voluntary climate-related data collection (inventories) and disclosures [22]. Similarly, a Duke University study from 2021 provided case studies on the high costs of voluntary climate disclosures and noted further that the questionable quality of much Scope 3 data raised particular concerns among some companies if such disclosures were incorporated into mandatory reporting regimes [23].

Whether the amount of money companies spend on collecting and disclosing emissions data is too much or too little is not the climate-relevant question. Rather, the question is whether the current set of requirements for accounting and disclosure is still the best way to get the most decarbonization impact. The legacy theory of ‘inventories and disclosure first, interventions later’ is only climate optimized if the result is more decarbonization impact (accounting for the fact that strict and complete inventory construction consumes significant corporate resources).

Attributional accounting and disclosure of inventories can lead to interventions that have real impact. But a climate-optimized corporate rules-and-rewards ecosystem should incentivize and reward companies for interventions that lead to the most decarbonization impact. Yet the current approach to and virtually exclusive focus on inventories undercuts this proposition.

Attributional accounting and disclosure of inventories canlead to interventions that have real impact. But a climate-optimized corporate rules-and-rewards ecosystem should incentivize and reward companies for the interventions that lead to the mostdecarbonization impact. Yet the current approach to and virtually exclusive focus on inventories undercuts this proposition.

Second: fix the mis-incentives in Scope 2

As discussed, current Scope 2 accounting rules allow for the creation of inventories that do not accurately reflect emissions from electricity use; and leading recognition and goal-setting programs incentivize and reward changes in inventories without any requirement for evaluating and measuring actual emissions impact from energy use and procurement interventions. A modernized rules-and-rewards ecosystem should fix these problems.

Scope 2 inventories do have value. Both companies and stakeholders benefit from knowing more about what emissions were caused by a company’s actual electricity use, and thus an inventory should, as advertised, represent a ‘true and fair’ account of those emissions.⁴ At the very least, therefore, clean-energy transactions and interventions on grids that do not supply electricity to a company and thus have no impact whatsoever on its emissions, should not change a Scope 2 inventory.

Perhaps even more important than making Scope 2 inventories a more ‘true and fair’ account of the emissions resulting from a company’s energy use, is to make actual decarbonization impact central to how companies are incentivized and rewarded for their electricity procurement decisions. With only current market-based inventory rules to guide clean energy investment decisions, companies are equally rewarded for a deal done with a West Texas wind farm that has little climate benefit as for a new renewable project in West Virginia that would displace many more fossil emissions.

The rules-and-reward ecosystem should incentivize companies to assess the extent to which a clean generation project will displace fossil emissions, and then encourage (and perhaps eventually require) them to calculate and report the emissions impacts of their clean generation investments. Such new and additional calculations and reporting of the actual emissions impact of company electricity investments can stand alongside improved inventory reporting, but third-party leadership and recognition programs must change so as to encourage and reward interventions based on their beneficial climate impact and not just their ‘impact’ on Scope 2 inventories (which means that even a company’s clean energy transaction done in an entirely different grid region but that has significant emissions impact would be incentivized and credited, even if such a transaction has no effect on its reported emissions from its actual electricity consumption reflected in its Scope 2 inventory).

Third: refocus Scope 3 rules-and-rewards toward emissions impact

The good news is that a host of important efforts are underway among stakeholders to develop improvements to Scope 3 accounting and the treatment of Scope 3 by third-party disclosure and leadership programs. While there are many different views about the key problems and a number of ideas for fixes, there is clearly a growing consensus that real change is needed now.

Any such efforts must be guided by the same laser focus needed for assessing the entire ecosystem: maximizing the contribution that companies can make to decarbonizing the economy—in both the near and longer term. With that focus, a few key ideas must be considered.

The primacy of completing a Scope 3 inventory over identifying and making impact should be reconsidered. Companies should be directed towards and rewarded for actual impact, and not just given credit for inventory assemblage and subsequent changes in inventories that may or may not reflect actual decarbonization impact. Arguably, companies are asked to allocate too much of their climate spend using unactionable proxy information and stumbling around in the ‘dark’ of inadequate data, instead of being incentivized to shine a flashlight on specific emissions reduction opportunities. When such opportunities are identified, a company should be incentivized and rewarded for seizing those opportunities, even if it has not completed an inventory. That, in turn, means that Scope 3 rules—particularly as applied by ‘science-based’ leadership programs—should allow the use of market instruments and rigorous consequential accounting to find, execute on, and measure interventions to reduce, avoid, or remove GHG emissions—which is precisely what climate science demands.

The primacy of completing a Scope 3 inventory over identifying and making impact should be reconsidered. Companies should be directed towards and rewarded for actual impact, and not just given credit for inventory assemblage and subsequent changes in inventories that may or may not reflect actual decarbonization impact.

Fourth: elevate ‘consequential accounting’

The actual emissions impact of various types of corporate interventions can almost always be estimated and disclosed. When a new solar farm is put into service, for example, various methods can be used to estimate the actual GHG emissions avoided over a given period of time by calculating emissions from other types of generation sources that the new renewable project displaced. This approach is an example of ‘consequential accounting’. Yes, the Protocol allows reporting of consequential emissions calculations—but it is not required, is rarely used, and is not considered part of leadership and recognition programs.

Moving actual climate impact closer to the heart of the rules-and-rewards ecosystem means elevating the role of consequential accounting from its current status as a little-used aside in GHG accounting guidance and an irrelevance in leadership programs. Adoption of consequential accounting does not mean abandoning inventories and attributional accounting altogether. As described above, market-based attributional accounting of Scope 2 inventories can be improved to more accurately reflect emissions from electricity use, while consequential disclosure can help incentivize and reward buyers choosing procurements with greater real-world impact. In the context of Scope 3 (or, for that matter, Scope 2), consequential calculations and disclosure can be used to demonstrate actual emissions reductions to the atmosphere which in turn could be incentivized and rewarded in leadership and target-setting programs irrespective of how and whether underlying attributional accounting rules are changed.

Moving actual climate impact closer to the heart of the rules-and-rewards ecosystem means elevating the role of consequential accounting from its current status as a little-used aside in GHG accounting guidance and an irrelevance in leadership programs. Market-based attributional accounting of Scope 2 inventories can be improved to more accurately reflect emissions from electricity use, while consequential accounting can help incentivize and reward buyers choosing procurements with greater real-world impact. In the context of Scope 3, consequential accounting can be used to demonstrate the emissions impact of interventions in the value chain based and provide a tool for more fully incentivizing and crediting such interventions.

The methods for calculating consequential impact are not perfect, but the perfect must not be the enemy of the good. Certainly, there are costs associated with consequential accounting. But unlike many other costs incurred by companies today in keeping up with the demands of the rules-and-rewards ecosystem, consequential accounting costs are directly tied to emissions impact. Ideally, these costs can be balanced by relief from some inventory compilation requirements that do not lead directly to, or distract from, getting the most decarbonization benefit.⁵

Fifth: rethink the emissions ‘hierarchy’

The current system is deeply grounded in a ‘hierarchy’ that elevates some interventions over others based on criteria unrelated to their actual decarbonization impact. For example, ‘[t]he SBTi requires that companies set targets based on emission reductions through direct action within their own boundaries or their value chains’ [24] (by ‘emissions reductions’ they mean inventory reductions). But why prefer a ton of verified emissions reduction inside an inventory to a ton of verified emissions reduction outside of an inventory when it makes no difference whatsoever to the climate? If a company’s interventions result in actual reductions in emissions, does it really matter if those reduced emissions were inside its inventory or not?

It might be the case that the best emissions-impact car keys are to be found under the lamp posts of Scope 1, Scope 2, or Scope 3 inventories. But perhaps not. All things being equal, we might prefer (and if the cost is the same, a company would likely prefer) a ton of impact inside an inventory to one outside. But, particularly with the elevation of consequential disclosures, we can broaden the lens beyond impacts just within an inventory to real decarbonization impacts wherever those opportunities may be found. If companies are directly incented and rewarded for achieving more measured emissions impact, they will then try to get the most impact per dollar of climate spend. And if the next marginal dollar of corporate climate spend yields more impact outside of an inventory than inside, that is where the climate wants that dollar to go.

It might be the case that the best emissions-impact car keys are to be found under the lamp posts of Scope 1, Scope 2, or Scope 3 inventories. Perhaps not. All things being equal, we might prefer (and if the cost is the same, a company would likely prefer) a ton of impact inside an inventory to one outside. But particularly with the elevation of consequential disclosures, we can broaden the lens beyond impacts within an inventory to real decarbonization impacts wherever those opportunities may be found.

Sixth: treat market instruments as tools, not taboos

Incenting and rewarding companies for creating climate impact outside of their value chains does not necessarily mean they are creating or purchasing offsets. But market instruments like offsets can be a valuable tool to get more decarbonization impact per dollar of corporate climate spend.

Incenting and rewarding companies for creating climate impact outside of their value chains does not necessarily mean they are creating or purchasing offsets (or ‘carbon credits’). But market instruments like offsets can be a valuable tool to get more decarbonization impact per dollar of corporate climate spend.

As discussed above in the context of the hypothetical HVAC replacement interventions, these tools are, at best, disfavored by the rules-and-rewards ecosystem irrespective of actual emissions impact. Per SBTi: ‘[o]ffsets are only considered to be an option for companies wanting to finance additional emission reductions beyond their science-based target (SBT) or net-zero target’ [25]. Deporting offset interventions from the realm of what companies are today incented to achieve makes them essentially irrelevant. The question should be whether a given emissions reduction is verifiable, not whose supply chain it sits in.

The eschewing of offsets by the ecosystem is intentional. Beyond the judgment that it is more important that companies reduce their own emissions rather than someone else’s, resistance to companies taking actions outside of their inventories is often based on concerns that offsets may not actually represent real emissions reductions or could be based on reductions that would have happened anyway. If a market-based intervention does not result in real emissions reduction, avoidance, or removal that would not have occurred absent that intervention, then it certainly should not be incentivized or rewarded. But the fact that there are bad offsets does not mean that all offsets are bad. While giving ‘credit’ for a bad offset must be avoided, so should discouraging investment in verified offsets that yield real climate impact. Rigorous measurement and verification are essential to assure that every offset project is yielding real climate benefit that would not have occurred otherwise.

The fact that there are bad offsets does not mean that all offsets are bad. Rigorous measurement and verification that every offset project is yielding real climate benefit that would not have otherwise occurred is essential.

Climate science is clear: All actual tons of carbon are the same, and we need to reduce, avoid, and remove a lot of them very quickly. So why are some tons okay for a ‘science-based’ target and some are not? Again, the climate does not care where or in whose inventory a ton is reduced, avoided, or removed. If rigorously shown to result in real climate benefit and so long as no single ton is counted toward more than one company’s target, there really is no climate-centric reason to dissuade the use of market instruments that lead to real decarbonization impact.

The climate does not care where or in whose inventory a ton is reduced, avoided, or removed. If rigorously shown to result in real climate benefit, there really is no climate-centric reason to dissuade the use of market instruments that lead to real decarbonization impact.

Conclusion

The designers and keepers of the rules-and-rewards ecosystem can take great pride in having played an important role in spurring and guiding the dramatic increase in the number of companies around the world that have made commitments and investments to mitigate climate change. The shortcomings of the status quo are certainly not the result of any ill-intent on the part of those who designed and administer the current rules-and-rewards ecosystem, nor are companies to blame for directing climate spend toward suboptimal climate outcomes when they are simply following the rules and pathways laid out for them.

But it is a very different time today than when the rules and rewards were designed. Although some companies still need to be called out and pressured to take steps to reduce emissions and invest in climate impact, a growing number see climate change as a legitimate business issue and understand that proactive and meaningful climate leadership can lead to risk reduction and value creation. While keeping pressure on the laggards remains important, the ecosystem must modernize in order to better empower and reward the leaders so they can achieve more impact.

Ideally, the Greenhouse Gas Protocol and key leadership programs like SBTi both reform and improve together in order to enable and reward greater impact. But leadership programs can adopt the type of recommendations presented here even without or before changes to the Protocol. The type of stakeholder processes involved in such change can be a challenge, especially when decades of practices have become deeply imbedded and a veritable industry of consultants and providers has been created to service the status quo. And again, some will resist changing a system that has clearly succeeded in driving change over the past decades.

But if nothing else, change is demanded by the extent and imminence of the climate crisis. Therefore, it is not only fair, but imperative, that we hold every aspect of the rules-and-rewards ecosystem up to the light of urgency and ask if it can be better.

Acknowledgements

The author wishes to thank the many experts, practitioners, and climate advocates who shared their experiences and perspectives.

Study funding

This paper was made possible by the financial support of Green Strategies, Inc. and Meta Platforms.

Author’s contribution

Roger Ballentine (Writing—review and editing [supporting]).

Conflict of interest

None declared.

Data availability

The data underlying this article are available in the article and in its online supplementary material.

Notes

1

The terms and metrics of the rules and rewards ecosystem have more recently been proactively used in the design of programs and practices intended to present more corporate climate-related data and information to investors and shareholders—perhaps the most influential stakeholders for public companies. For example, in 2017, the Financial Stability Board created the Task Force on Climate-related Financial Disclosures (TCFD)—a framework by which companies calculate and disclose climate-related financial information for use by investors, lenders, and insurance underwriters in assessing corporate climate risk. In significant part, TCFD utilizes the data calculation methodologies of the Protocol. TCFD is now being merged into the International Sustainability Standards Board (ISSB), the market-leading investor-focused sustainability reporting initiative.

2

As described by the Center for Resource Solutions, ‘Whosoever owns the REC can claim those attributes of generation for a megawatt-hour of electricity consumption. In other words, the REC purchaser can claim to be the recipient of or to have used that megawatt-hour of renewable electricity… Since RECs are how we choose and access output from new and existing renewable electricity facilities, RECs are how we switch to a clean electricity product, which reduces our scope 2 emissions and our carbon footprint.’ Todd Jones, Scope 2 Greenhouse Gas Accounting for U.S. Renewable Energy, pp. 3–4, Center for Resource Solutions (9 January 2015). https://resource-solutions.org/wp-content/uploads/2015/07/Scope-2-Accounting-For-U.S.-RE.pdf

3

Scope 3, or ‘value chain’ emissions, include both ‘upstream’ emissions (focused on in this paper) as well as ‘downstream’ emissions (such as emissions from the use of a company’s products). Certainly, the exactitude of downstream emissions data calculations is also problematic, but unlike upstream emissions, often the sightline to emissions-impacting interventions is relatively clear. If a company redesigns its widget to be 10% more energy efficient, it can easily apply that performance improvement to its projections of sales and use of its widgets in order to calculate a downstream Scope 3 reduction.

4

And there can be improvements to how emissions from electricity use can be calculated—grid emission data that is temporally and locationally matched to company electricity use can be used to much more accurately measure and report induced emissions. Such data is increasingly available and would create a much more ‘fair and accurate’ Scope 2 inventory. Growing efforts by some companies to ‘match’ their load to clean energy generation on a 24-7 basis could be reflected—and recognized—with these enhanced calculations. The Protocol does ask companies to calculate and report a ‘location-based’ inventory by which companies multiply their electricity load by the average emissions intensity of their grid region. For several reasons, this is an inadequate as a ‘fair and accurate’ accounting of emissions from electricity use. First, available average emissions data across a grid region is a very rough reflection of the actual emissions characteristics of the region at any given time or location; second, a location-based calculation does not reflect any actions taken by the reporting company even if the transaction directly impacted its emissions from electricity use (such as installing a rooftop solar system); and third, all leadership programs are based on changes to market-based inventories and thus it is changes to that inventory that motivates corporate interventions.

5

The marketplace is rapidly developing increasingly accurate methodologies for calculating the emissions impact of projects and interventions—including new carbon-free generation resources. For example, REsurety uses a ‘locational marginal emissions’ approach to measure the tons of carbon emissions displaced by one MWh of clean energy injected to the grid at a specific location and a specific point in time. WattTime uses data-driven marginal emissions analyses to measure and compare the avoided emissions of different potential clean energy generation sources.