Scope 1 and 2 emissions

Scope 1 and 2 emissions are direct and indirect greenhouse gas (GHG) emissions, respectively, that result from a company's operations and energy consumption. These emissions are central to Environmental, Social, and Governance (ESG) investing frameworks, which assess a company's impact and risk related to climate change and broader sustainability efforts. They represent a significant portion of an organization's overall carbon footprint and are key metrics for measuring progress toward sustainability goals and managing climate risk. Understanding Scope 1 and 2 emissions is fundamental for companies aiming to improve their environmental performance and for investors conducting thorough investment analysis.

History and Origin

The classification of greenhouse gas emissions into Scope 1, 2, and 3 originated with the Greenhouse Gas Protocol (GHG Protocol), a globally recognized standard for measuring and managing GHG emissions. Launched in 1998 by the World Resources Institute (WRI) and the World Business Council for Sustainable Development (WBCSD), the GHG Protocol established the Corporate Accounting and Reporting Standard in 2001. This standard provides a comprehensive framework for companies and other organizations to prepare a corporate-level GHG emissions inventory. The methodology, including the categorization of emissions, was developed to bring consistency and transparency to emissions reporting.¹⁶, ¹⁷, ¹⁸ The GHG Protocol's guidance has become the de facto international standard, enabling businesses to measure, quantify, and report their own emission levels to support global efforts to manage and reduce greenhouse gases.¹⁴, ¹⁵

Key Takeaways

• Direct Emissions (Scope 1): These are emissions from sources owned or controlled by the company, such as emissions from burning fuel in company vehicles or on-site combustion in boilers.
• Indirect Emissions (Scope 2): These are emissions from the generation of purchased electricity, heat, or steam consumed by the company.
• Mandatory Reporting: Many regulatory bodies and investment frameworks increasingly require or encourage companies to report on their Scope 1 and 2 emissions.
• Baseline for Reduction: Tracking Scope 1 and 2 emissions provides a critical baseline for companies to set reduction targets and implement strategies to decarbonize their operations.
• Investor Interest: Investors use Scope 1 and 2 emissions data to evaluate a company's environmental performance, corporate social responsibility, and exposure to transition risks.

Formula and Calculation

The calculation of Scope 1 and 2 emissions involves multiplying activity data by relevant emission factors. Activity data refers to the quantitative measure of a process or activity that results in GHG emissions (e.g., liters of fuel consumed, kilowatt-hours of electricity purchased). Emission factors are coefficients that quantify the GHG emissions per unit of activity data (e.g., kg CO2e per liter of fuel).

Scope 1 Emissions Calculation:
For direct combustion:
$\text{Scope 1 Emissions} = \sum (\text{Fuel Consumed}_i \times \text{Emission Factor}_i)$
Where:

• (\text{Fuel Consumed}_i) = Volume or mass of fuel type (i) consumed (e.g., gasoline, natural gas).
• (\text{Emission Factor}_i) = GHG emissions per unit of fuel type (i) (e.g., kg CO2e/liter, kg CO2e/m³).

For industrial processes or fugitive emissions, specific methodologies apply based on industry standards.

Scope 2 Emissions Calculation:
For purchased electricity (location-based method):
$\text{Scope 2 Emissions} = \text{Electricity Consumed} \times \text{Grid Emission Factor}$
Where:

• (\text{Electricity Consumed}) = Total electricity purchased by the company (e.g., kWh).
• (\text{Grid Emission Factor}) = Average GHG emissions from the electricity grid where the electricity was consumed (e.g., kg CO2e/kWh).

Companies also have the option to use a market-based method for Scope 2, which considers contractual instruments like Renewable Energy Certificates (RECs) to reflect the emissions of the electricity they specifically choose. Accurate emissions reporting requires diligent data collection and adherence to established standards, such as those provided by the GHG Protocol.

Interpreting Scope 1 and 2 Emissions

Interpreting Scope 1 and 2 emissions involves more than just looking at a raw number; it requires understanding the context of the company's industry, operational footprint, and reduction efforts. A high absolute number of emissions might be expected for heavy industries, but the crucial aspect is the trend over time and the company's intensity metrics (e.g., emissions per unit of production or revenue). A declining trend in Scope 1 and 2 emissions, especially relative to growth in output, indicates improved operational efficiency and a commitment to decarbonization.

Stakeholders, including investors, regulators, and customers, use this data to evaluate a company's genuine commitment to Net Zero targets and its overall environmental performance. A company's ability to reduce these emissions can signal strong management of climate risk and innovative practices that may lead to long-term operational savings and competitive advantages. Furthermore, transparent disclosure helps stakeholders assess the company's financial reporting and overall compliance with evolving environmental standards.

Hypothetical Example

Consider "GreenBuild Co.," a construction company. In 2024, GreenBuild Co. reports its Scope 1 and 2 emissions.

Scope 1 Emissions: GreenBuild owns a fleet of diesel-powered construction vehicles and operates on-site generators. In 2024, their vehicles consumed 500,000 liters of diesel, and generators used 100,000 liters of diesel. Assuming an emission factor of 2.68 kg CO2e per liter of diesel, their Scope 1 emissions would be:
( (500,000 + 100,000) \text{ liters} \times 2.68 \text{ kg CO2e/liter} = 1,608,000 \text{ kg CO2e} )
This translates to 1,608 metric tons of CO2e.

Scope 2 Emissions: GreenBuild's offices and temporary on-site facilities consumed 1,500,000 kWh of purchased electricity. If the regional grid emission factor is 0.4 kg CO2e per kWh, their Scope 2 emissions would be:
( 1,500,000 \text{ kWh} \times 0.4 \text{ kg CO2e/kWh} = 600,000 \text{ kg CO2e} )
This translates to 600 metric tons of CO2e.

For 2024, GreenBuild Co.'s total Scope 1 and 2 emissions sum to 2,208 metric tons of CO2e. To reduce this, GreenBuild might consider investing in electric construction vehicles or installing solar panels at their permanent office locations. This example illustrates how a company calculates its direct and purchased energy-related emissions, forming a basis for future reduction strategies. Monitoring such metrics is crucial for shareholder engagement on environmental performance.

Practical Applications

Scope 1 and 2 emissions data has numerous practical applications across various sectors:

• Corporate Strategy: Companies use this data to identify emission hotspots, set science-based reduction targets, and develop decarbonization strategies. This can involve transitioning to renewable energy sources, improving energy efficiency in operations, or upgrading vehicle fleets.
• Regulatory Compliance: Governments and regulatory bodies worldwide are increasingly mandating or proposing disclosures of Scope 1 and 2 emissions. For instance, the U.S. Securities and Exchange Commission (SEC) has proposed rules that would require public companies to include certain climate-related disclosures, including Scope 1 and 2 emissions, in their financial reporting.
  ⁹, ¹⁰, ¹¹, ¹², ¹³* Sustainable Finance: Investors and lenders use Scope 1 and 2 data to assess climate risk and identify investment opportunities in companies with strong environmental performance. This data informs decisions related to green bonds and ESG-focused funds.
• Supply Chain Management: While Scope 1 and 2 are direct to the reporting entity, understanding these emissions within a company's direct operations can inform efforts to encourage similar improvements across its broader supply chain.
• Reputation and Brand Value: Transparent and robust reporting of Scope 1 and 2 emissions, coupled with demonstrable reduction efforts, can enhance a company's reputation, attract environmentally conscious consumers, and mitigate risks of greenwashing. Many organizations, such as the UN Global Compact, emphasize the importance of corporate climate action and setting ambitious emissions reduction targets.
  ⁴, ⁵, ⁶, ⁷, ⁸

Limitations and Criticisms

While Scope 1 and 2 emissions reporting provides valuable insights, it is not without limitations and criticisms. One significant challenge lies in the accuracy and verifiability of the reported data. Companies may face difficulties in collecting precise activity data, especially across diverse global operations. The selection of appropriate emission factors can also vary, leading to inconsistencies. Critics point to the complexity of ensuring data integrity and the potential for companies to engage in "greenwashing" – presenting a misleadingly positive environmental image – if disclosures are not robustly audited.

Fur², ³thermore, the focus on Scope 1 and 2 alone can sometimes lead to an incomplete picture of a company's total environmental impact. While direct and energy-related emissions are critical, for many businesses, a substantial portion of their carbon footprint may reside within their value chain (Scope 3 emissions). Without comprehensive Scope 3 reporting, a company could appear to have a low impact while externalizing significant emissions. The voluntary nature of detailed external auditing in some jurisdictions can also impact the reliability and comparability of data across different entities.

¹Scope 1 and 2 Emissions vs. Scope 3 Emissions

The distinction between Scope 1, 2, and Scope 3 emissions is crucial for a complete understanding of a company's environmental impact.

• Scope 1 Emissions are direct GHG emissions from sources that are owned or controlled by the reporting company. Examples include emissions from company-owned vehicles, on-site industrial processes, or boilers used for heating.
• Scope 2 Emissions are indirect GHG emissions from the generation of purchased electricity, heat, or steam consumed by the reporting company. These emissions physically occur at the facility where the electricity, heat, or steam is generated (e.g., a power plant), but they are accounted for by the company that purchases and consumes the energy.

In contrast, Scope 3 Emissions are all other indirect GHG emissions that occur in a company's value chain, both upstream and downstream. These are emissions that are not directly produced by the company itself (Scope 1) and are not from the generation of purchased energy (Scope 2). Examples include emissions from purchased goods and services, business travel, employee commuting, waste generated in operations, and the use or end-of-life treatment of sold products. While Scope 1 and 2 are often easier to quantify as they relate directly to a company's immediate operations and energy bills, Scope 3 emissions can be far more extensive and complex to measure, yet they often represent the largest portion of a company's total materiality carbon footprint.

FAQs

Q: Why are Scope 1 and 2 emissions important for investors?
A: Investors use Scope 1 and 2 emissions data to assess a company's exposure to climate risk, evaluate its progress on environmental goals, and identify potential financial liabilities related to carbon pricing or stricter regulations. It helps them make informed decisions about ESG investing.

Q: Are Scope 1 and 2 emissions mandatory to report?
A: The mandatory nature of reporting Scope 1 and 2 emissions varies by jurisdiction and company type. Many countries and regions have established or are proposing regulations that require or encourage public disclosure, particularly for larger companies. The GHG Protocol provides a widely adopted framework, even where reporting is voluntary.

Q: How can a company reduce its Scope 1 emissions?
A: Companies can reduce Scope 1 emissions by transitioning their vehicle fleets to electric or hybrid models, improving the energy efficiency of on-site industrial processes, switching to lower-carbon fuels, or capturing and storing emissions from their operations. These efforts contribute to a reduced carbon footprint.

Q: What is the difference between location-based and market-based Scope 2 emissions?
A: The location-based method reflects the average emissions intensity of the grids where electricity consumption occurs. The market-based method, conversely, reflects emissions from electricity that companies have purposefully chosen via contractual instruments, such as direct contracts with renewable energy generators or the purchase of green bonds or unbundled renewable energy certificates.