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Decarbonisation and new energies offer vast long-term investment opportunities. This decade will be crucial as we seek to slow the pace of physical climate change. Scaling the solutions we need now, investing in the ones we might need 10 years later, and transforming the essential industries we currently rely on all need to happen simultaneously and faster than ever before.
As long-term investors attracted by the potential of disruptive innovation, we already hold a range of solutions innovators and key transformers for our clients – from synthetic biology and battery makers to mining companies and high-voltage cable manufacturers. We suspect that companies such as these will create markets and take share from others by delivering goods and services that enable decarbonisation. Knowing more about the scale and distinctiveness of each company’s potential contribution to carbon reduction can provide investment insight into the prospect for profitable growth and competitive edge relative to peers.
Over the last three years, our Climate team has been developing and testing a methodology to estimate the emissions ‘avoidance’ enabled by a company’s products.
Avoided emissions are not a new concept. Put simply, they are the change in emissions released from doing something different to the status quo. What complicates this are the assumptions that must be made about the difference between the two and how these relative pathways might change over time. The diagram below gives a very simple example of how avoided emissions work. Without the solution, society’s emissions rise. With the solution, they fall. Of course, pathways vary significantly between companies and types of solution, and both the emissions of the baseline scenario and solution can be dynamic.
We’ve explained this process in more detail within our Avoided Emissions Methodology paper, but outline some of the core principles of our process below:
Forward-looking
We take a forward-looking approach to any estimates, first understanding how a company’s product or service might be reducing emissions today and then forecasting how that might change over the next 10 years. This process is inherently tied to investment research, using growth assumptions from company analysis to also inform our avoided emissions calculations.
Dynamic baselines
The rate of change is happening faster than we could imagine. As such, a company’s output in one year will be displacing a different set of products 10 years down the line. We expect our energy supply to decarbonise, as well as the ways in which we source and process raw materials. All of this contributes to a changing emissions baseline that meets Paris-aligned ambitions to half emissions by 2030 and achieve net zero by 2050. Using dynamic baselines allows us to model this in our calculations, ensuring each individual year is calculated against the most realistic baseline in that year.
Attribution
No one single company is responsible for the avoided emissions from a climate solution. Taking an electric vehicle, for example, the manufacturer may put the car together and, in some cases, may be relatively vertically integrated, but there is a plethora of companies within a car’s value chain that have also contributed. From the company that made the wiring harness, to the miner that provided the lithium for the battery. This needs to be reflected in an avoided emissions calculation, but mapping out every company involved would be extremely challenging. We, therefore, take a subjective approach with three categories of attribution: 50 per cent for critical companies, 35 per cent for core companies and 15 per cent for those that are supporting. The framework for how we organise these companies is explained in more detail within our Avoided Emissions Methodology paper.
How do we use avoided emissions?
As we continue to develop the methodology we are learning more about how avoided emissions data can be used in different stages of an investment process and to achieve a variety of objectives.
It can be used to gain a better understanding of the scale of new markets that might emerge for companies. Understanding the importance and how it is positioned in the value chain can also add insight in relation to margins and pricing power.
For impact driven strategies, we can use these estimates to understand the potential climate impact. It can also be used to compare potential impact between companies where we are clear about the assumptions we have made, and to understand where in a value chain the greatest opportunity for carbon reductions might be.
Importantly, we don’t see the use of avoided emissions calculations as an ‘offset’ to any actual financed emissions from other companies within investment portfolios and we ensure that we use robust and peer reviewed data inputs where available. As more and more companies start to estimate avoided emissions themselves, we can support them in developing best practice.
What’s next?
We’re publishing this methodology to share our work more broadly, acknowledging that this is still an emerging field that we want to contribute to. We’re continually developing our approach and learning as we put more companies through the process, working directly with Matthew Brander and Michelle O’Keeffe of the University of Edinburgh’s Carbon Accounting department. We’re keen to hear feedback, work with others who are developing similar approaches and continue using this data to better understand potential solutions to reducing the impacts of climate change.
To read our full Avoided emissions methodology paper please click here.
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