Concept Tool Launched at COP21 Offers Market-Based Climate Solutions

A month has passed since COP21 President Laurant Fabius struck the gavel heard round the world and formally adopted the first draft of the Paris Agreement, an unprecedented deal struck by nearly 200 nations to address climate change. As we speak, national and sub-national governments are grappling over how to make good on their commitments to a low-carbon future. One thing is clear: We'll need a multi-pronged effort to realize the agreement's goal to keep global temperature rise "well below" 2 degrees Celsius — and government action is only the beginning.

By themselves, national commitments associated with the Paris Agreement will only limit warming to 3.5 degrees Celsius, Oscar-nominated filmmaker Josh Fox pointed out in a recent post on TriplePundit. Private-sector engagement is one way to fill this gap, and luckily for us, a shift is already underway.

"In addition to the momentum associated with carbon pricing on the national and sub-national level, capital markets are now recognizing carbon risk as a material risk," Joe Madden, co-founder of EOS Climate, said during a breakout session at COP21 focused on environmental standards. "They're reacting in the form of moving capital away from carbon-intense assets and toward carbon-efficient assets."

This recognition, driven in large part by the climbing tally of stranded fossil fuel assets (now pegged at $2 trillion), is a significant one. Market actors are already beginning to employ methods to shift funds away from risky carbon assets, such as low-carbon indices and exchange-traded funds, but it's not yet enough to move the needle. Markets need more information, Madden said, and that's where the standards community comes in.

"When you look at capital markets, there's some very low-hanging fruit with regards to carbon mitigation: Commodity markets, in general, trade assets that are undifferentiated," he explained to a room of standards professionals, company executives and journalists in Paris.

"The greenhouse gas impacts and many other [environmental and social] externalities are not considered in the private marketplace. So, when you think about where standards go, this to me is the biggest opportunity for standards themselves in enabling the markets to differentiate not just by materials but by impact."

Okay, so what does this really mean? Madden, who presented a concept tool at COP21 to differentiate and reward carbon efficiency in commodity production, used the example of two barrels of oil: A recent analysis of petroleum oils from around the world found more than an 80 percent difference in their lifecycle greenhouse gas emissions per barrel.

This means that two barrels of oil that appear to be identical — and may even come from the same processing facility — can differ in their lifecycle emissions by up to 80 percent, based on the practices employed at the initial extraction point. On the open market, purchasers will opt for the cheapest barrel of oil by default, even though it may very well carry significantly higher GHG impacts that introduce more carbon risk to the base of the purchaser's supply chain.

"Now, the interesting thing is that similar graphs can be made for palm oil, rice, soybeans, different metals or natural gas," Madden continued.

Filling the information gap: The Carbon Impact Factor

"Commodity markets are quite efficient at getting to the lowest price," Madden told TriplePundit in an exclusive interview. "Because commodities are undifferentiated, they go to the lowest price. So, if that price doesn't include any other information about impact ... then the materials that succeed in the market are going to be the lowest financial cost. Period. Without any other consideration."

As institutional investors grow more concerned about the financial risks associated with carbon-intense assets, multinational companies are looking to improve carbon efficiency in their supply chains in order to woo investors (or at least keep them happy). But the data these companies are tracking — and reporting to investors — are often incomplete.

Most companies report only their direct emissions (Scope 1) and those from the generation of purchased electricity (Scope 2), with a much smaller percentage reporting indirect emissions that occur in the supply chain (Scope 3). But for several sectors, such as the agricultural sector, the impact of Scope 3 is far higher than the others — meaning the emissions that go unaccounted for are often those doing the most damage.

This isn't an easy problem for companies to solve, especially when it comes to commodity purchasing: At present, it's very difficult — if not impossible — for an individual company to trace those barrels of oil or bags of grain back to the initial extraction point and evaluate their carbon intensity.

That's where the new concept, dubbed the Carbon Impact Factor or CIF, can be of help. This family of financial instruments allows commodity buyers to invest in low-carbon production practices and reward the producers that implement those low-carbon practices. By utilizing technologies already in use in the capital markets — such as mobile technology, big-data analytics and blockchain (the technology that enables cryptocurrencies like Bitcoin) — CIF places a direct value on carbon efficiency practices associated with a given commodity, and communicates this information to the market for use in purchasing decisions.

As Madden put it, the CIF concept is "an evolution of a lot of hard work put in by other people." It builds on existing technologies, as well as standards and verification mechanisms (think: RECs or certifications like fair trade). None of these concepts are new, but bringing them together and into the commodities market is — and it could revolutionize raw materials sourcing.

Not an offset, nor an inset

Further, metrics (fittingly called CIFs) can be purchased by multinationals to demonstrate their efforts to reduce carbon intensity within their supply chains. A CIF is not a carbon offset, nor a carbon inset. It is a measure of carbon efficiency relating specifically to the raw materials a company purchases, which represent emissions that now go largely unaccounted for.

"[The concept] is specifically designed to embody metrics that are associated with certain lower-impact producers, and transfer those metrics to the commodity markets themselves," Madden explained. "Purchasers can buy commodities and buy the metrics."

This model has a threefold benefit for commodity producers, multinational companies and customers. Producers are given incentive to adopt low-carbon practices, and they receive more customers and more money for their products as a result. Multinationals can intentionally reduce carbon risk at the base of their supply chains by purchasing carbon-efficient commodities, as well as CIF credits that allow them to communicate these decisions to their stakeholders. And customers in search of more sustainable products get even more assurance that the items they're purchasing have a lesser impact, down to the raw materials.

"It goes beyond the traditional corporate social responsibility (CSR) marketing," Madden said of the benefits for companies. "It's very much a financial risk instrument that can also be used to communicate good corporate governance."

Of course, one of the primary stakeholder groups with whom companies are looking to share this information are those good ol' institutional investors — who also stand to benefit from commodity differentiation as the divestment movement continues to grow in strength.

"The flip-side of divestment is investment," Madden told 3p. "Where is the money that's coming out of carbon-intense resources going? [Investors] need signals of where carbon efficiency is ... but it's very difficult at present to understand carbon efficiency. This is a way of mixing the bottom of the global supply chain with the top of the financial system."

From concept to reality

"There are a lot of small innovations contained in this concept," Madden told us. "Link those smaller innovations together, and you get a transformational system. In order to move the concept forward, we determined that we had to put out a comprehensive thought piece [downloadable as a PDF], so that all of the different global stakeholders could take a look at this and see how these link together."

Madden told us that the feedback has been positive so far, but it will likely be a while before we see this concept in use in the open market. "The challenge remains that we're going to have to implement it. We're going to have to make it real," he told 3p.

"That's going to take a very, very concerted and directed effort that consists of the stakeholders in the system coming together to further define and really make the system a reality. There's already been expressed interest from significant global entities around, 'Where do we go from here?' So, that would be the next step."

The developers of the CIF concept have a long row to hoe, but Madden told us that the Paris Agreement bolsters this type of collaboration for a low-carbon future.

"The Paris Agreement did an amazing job at signaling that the global community is serious about addressing climate change, and they left the flexibility open for real innovation. They did not preclude innovation by over-engineering a regulatory fix," Madden told us. "So, I think this type of approach is entirely compatible with the overall design of what has come out of Paris. It's a way for both policymakers and market participants to effectively demand and communicate carbon efficiency, which is ideal."

Image credit: Mary Mazzoni