18/06/06

Carbon Management & Carbon Neutrality in the FTSE All-Share

Increasingly, companies are seeking to demonstrate that they are managing the financial risks from climate change impacts by using ‘carbon neutrality' as part of their response to a lower carbon economy. However, there is no commonly agreed definition of the term ‘carbon neutral'. Nor there has been debate about the role and relative efficacy of ‘carbon neutrality' compared to other carbon management strategies, or its relevance as applied in different business sectors.

In partnership with the Environment Agency Pension Fund, we asked Trucost, an environmental research agency, to address these issues. The resulting report defines the concept of ‘carbon neutrality' as a state whereby, in any one year, a business has no net carbon emissions as these have been either reduced in absolute terms for the business and the remainder offset, or offset without any attempt at reducing the emissions generated by the business. The report also looks at which companies are using ‘carbon neutrality', and discusses the use of offset mechanisms in an effective carbon management strategy.

The report recommends that companies that are considering how to manage their carbon emissions should follow a well-defined sequential process that starts with accurate measurement of the level of greenhouse gas emissions (GHGs) associated with their business activities. After measuring their GHGs, companies should first aim to achieve absolute reductions. Reducing GHGs, sometimes referred to as internal abatement, should be the starting point of any climate change strategy and is often the most economical step in reducing corporate emissions.

The EU Emissions Trading Scheme allows companies with high abatement costs to purchase carbon allocations from other companies with lower CO2 abatement costs. For companies regulated by trading schemes, emission trading is usually the most economic method of reducing emissions after all reasonable energy efficiency measures have been implemented.

Companies also have the option of offsetting their emissions. Broadly, there are two ways in which this can be done: Kyoto-compliant and voluntary schemes. The Clean Development Mechanism and Joint Implementation are Kyoto-compliant schemes that award credits for emissions reduction in return for investment in projects that directly reduce emissions. These schemes are currently in limited supply, although they are expanding rapidly and are subject to strict criteria. This often means that the resulting carbon credits cost more than those produced by voluntary schemes.

Voluntary schemes have been running for many years and are often an inexpensive way to achieve net emissions reductions. There is still some debate about the scientific effectiveness of forestry sequestration, which is used in most of these schemes, although some companies are now offering offsets derived from more technological means. The voluntary offset market is currently unregulated and the actual emissions offset are often difficult to measure and verify.

The report concludes that a credible carbon management programme will highlight the process that the company has followed in order to determine the appropriate strategy and be transparent about the cost implications of each option chosen. Clear and transparent disclosures regarding the cost of abatement, trading and offsetting schemes will provide the opportunity for more accurate assessments of the opportunities and risks facing companies.

Julie McDowell, Head of SRI Research at Standard Life Investments

First published in Finance Week on 18 July 2006

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