Accounting for Supply Chain Emissions

We need a new supply chain emissions reporting framework. Photo created by Nicolas Lama using DALL·E 2.  

Can we reform our current economic system to account for climate change before it's too late? Or will a globalized capitalist economy driven by short-term price efficiencies never be able to account for the long-term climate impact of profit-seeking endeavors? The answer to this question will play out in the decades to come as nations around the world scramble to decarbonize their economies in the face of increasingly imminent environmental disaster. 

While some experts argue that technology will resolve climate change before a systemic societal reform is necessary, the reality is that most innovations would not be deployable at scale within the necessary time horizon, meaning that an entirely technological solution would likely be insufficient. Carbon capture and storage (CCS), a technology that traps carbon dioxide emissions before they enter the atmosphere, will be one of the most important decarbonizing technologies in our path to net zero emissions; yet even in its most ideal form, it cannot capture 100% of emissions and is still years away from feasibility in practice. Furthermore, CCS technology might even fuel more oil extraction through a process called enhanced oil recovery, in which the captured carbon is reinjected into oil fields to loosen shale. Clearly, without systemic change, CCS is susceptible to corruption and even liable to promote the expansion of oil and gas. Though technology will play a crucial role in averting the climate disaster, as Harvard Prize Fellow in Economics, History, and Politics, Jacob Moscona has argued, “We cannot simply innovate our way out of danger.” 

If technology alone can’t save us, what can? Unfortunately, if we take economist John Galbraith’s argument that production creates demand, a purely consumer-oriented approach won’t be enough either. Systemic changes in supply, it seems, will be a necessary component in our transition to an environmentally sustainable society. Though some argue that systemic change needs to be on a revolutionary scale, realistically, capitalism won’t be overthrown within the timeframe in which action must be taken. So the question remains, how can we realistically reform our economic system sufficiently fast enough to cultivate a sustainable society?

A recent article published in the Harvard Business Review by Harvard and Oxford academics, Robert Kaplan and Karthik Ramanna, respectively, might hold part of the answer. Carbon emissions, they propose, should be reported in the same accounting format as the rest of a company’s financial disclosures. Along with an annual income statement, balance sheet, and cash flow statement, companies should be required to disclose their greenhouse gas emissions per unit of production in an additional statement that Kaplan and Ramanna term “E-liability,” or environmental liability. Each product, finished or not, is tagged with its associated portion of emissions, or E-liability, which is assumed by the company upon purchase and passed on through the supply chain at each sale. Every time a company along the supply chain alters or transports the product through a process that generates carbon emissions, the product’s E-Liability tag is updated. Government mandate of the E-Liability accounting standards would be crucial to enforcing uniform information that could be shared and added to through the supply chain. By the end of a product’s journey through the value chain, it will have accumulated an E-Liability tag that transparently informs buyers as to exactly how much carbon was emitted in its production and at what point in the chain those emissions were generated. The main benefit of this program, however, would not be its effect on consumer choice: although consumers would be given information about products’ accumulated carbon footprint to make more informed decisions, E-liability accounting has many more important benefits.

First, the accounting system could serve as a universal reporting standard that would give the environmental aspect of the latest environmental, social, and governance (ESG) investing trend the rigor, consistency, and accountability that it so desperately needs. In its current form, the lack of standardized reporting for ESG metrics has allowed companies to feign engagement in the climate movement for optics without actually cutting emissions, leading many to dismiss claims of sustainable business practices as PR “shams” or greenwashing.

Not only are there little-to-no regulatory requirements for climate reporting, but even the existing standards in the E.U., which might soon be similarly enforced in the U.S., are flawed. Both the E.U. and the proposed U.S. regulations rely on the Greenhouse Gas (GHG) Protocol. Responding to research that emphasizes the importance of supply chain decarbonization, the GHG Protocol aims to provide investors with a sense of emissions across a company’s value chain. If a company’s supply chain emissions are ignored, carbon emissions can be hidden when a company chooses to outsource their most carbon-intensive activities. To render transparent a company’s full contribution to carbon emissions, the GHG Protocol calls for companies to report carbon emissions directly associated with their production (Scope 1), emissions that are produced from purchased electricity and other energy (Scope 2), and emissions from downstream and upstream activities within their value chain (Scope 3). 

In a comment letter to the Securities and Exchange Commission (SEC) replying to their recent proposal mandating that public companies listed in the U.S. report material Scope 3 emissions, Kaplan and Rammana explain that reliance on the Scope 3 framework to illuminate supply chain emissions is fundamentally faulty. The GHG Protocol itself even recognizes that Scope 3 “is not designed to support comparisons between companies” because of “differences in inventory methodology, company size or structure.” Beyond measuring a company’s internal progress toward emissions reductions, the whole point of climate-related reporting is to allow investors to compare emissions levels across companies, so a framework that fails to facilitate this clearly must be abandoned. 

Not only does the GHG Protocol framework fail to meet the essential comparative function of reporting due to the ambiguity of its standards, but Kaplan and Ramanna point out that it is nearly impossible for companies to gather emissions data from all of the companies within their value chain. “All companies obviously know their immediate customers, but few know the identity of their customers’ customers, and, especially, all the customers of its customers’ customers,” the letter explains. Because it is impossible for companies to collect accurate and complete Scope 3 data, companies wind up filling in the gaps with industry averages, further undermining the ability to use Scope 3 emissions as a comparative metric.

The last nail in the GHG Protocol’s coffin is the fact that it equally weights a company’s liability in its upstream and downstream emissions, which ignores the reality that “a company’s ability to influence and measure GHG emissions is not symmetric between suppliers and customers.” Kaplan and Ramanna argue that a company has much more influence over its suppliers than it does on the company that the customer of its customer supplied. 

Whilst the GHG Protocol succeeds in facilitating a much-needed standardization of direct emissions, it fails to provide a good reporting framework to capture the carbon impact of a firm’s supply chain. This is a critical failure because Scope 3 emissions represent on average 84% of a company’s total carbon footprint, meaning that the GHG Protocol only accurately accounts for 16% of a company’s emissions. 

This startling failure necessitates a complete overhaul of how we report supply chain emissions, exactly what Kaplan and Ramanna’s carbon accounting method hopes to offer. In addition to standardizing the environmental component of ESG metrics, this method provides several other benefits. A second benefit is that unlike carbon offsets—which obscure the product from the emissions it generates by allowing companies to counter their emissions through indirect investments in carbon credits—E-liability directly tags the product with its proportional emission, making targeted emission reduction much more effective. 

A third benefit is the potential identified by Kaplan and Ramanna for an E-liability tax that could use value-added or capital gains tax structures to tax companies’ “end-of-period E-liability balance” that might accumulate if a company is unable to sell high-emission products.

Fourth, the method would in effect generate a competitive market for low emissions at each point in the supply chain. The threat of assuming taxable E-liability upon purchase would mean that companies are incentivized to buy the product with the lowest associated emission, competitively inducing emission reduction innovation across the supply chain.

Lastly, streamlined reporting and efficient, transparent sharing of information through the supply chain would be more conducive to rigorous third-party auditing as well as resolve the inefficient double-counting feature of Scope 3 reporting, which requires the direct and indirect emitter to collect separate measurements.

As the U.S. begins to craft climate reporting standards to give rigor and accountability to the sustainable investor revolution, getting the supply chain emissions reporting framework right from the getgo will be critical to shaping a sustainable future. Given how important it is to tackle emissions reduction from a supply chain perspective, and the shocking inadequacy of the status quo, a governing body with the purview to implement standards across the business sector will need to mandate a cohesive reporting framework. We won’t win the fight against climate change without effectively engaging the business sector. Technological solutions and systemic change to how the economy impacts the climate are necessary. If regulators listen to Kaplan and Ramanna, the U.S. could implement a simple and effective carbon accounting method and be a model for the rest of the world.

Carmen Vintro is a Managing Editor for CPR and a senior at Barnard studying English with minors in philosophy and economics. When she’s not submerged in a Keats or Whitman poem, or conversing with friends about how we are living in the Heideggerian technological age, Carmen loves thinking a little more practically about where the world is heading.