Climate debt accounting as a weapon against global warming

The April 2022 IPCC ‘Mitigation of climate change report’ is clear: if we want to limit global warming to 1.5°C then we need a thorough and immediate action plan that reduces our CO₂ emissions. At present, businesses are also coming under pressure to reduce their CO₂ emissions from investors, interest groups, politicians, and company directors themselves. More and more businesses are also obliged to report on their CO₂ emissions and sustainability activities. The European Commission, the ISSB (International Sustainable Standards Board) and the SEC (Securities Exchange Commission) have recently increased the stringency of their proposals around climate and sustainability reporting even further. Whilst today it is predominately listed companies that report on their carbon footprint, private companies will also do this in future. However, the CO₂ protocol that businesses follow for this is insufficient and open to manipulation (greenwashing), even under the new standards.

That CO₂ protocol asks businesses to report on their Scope 1, 2 and 3 emissions. Scope 1 relates to the direct CO₂ emissions caused by the organisation’s internal sources. Scope 2 encompasses indirect CO₂ emissions from the generation of electricity or heat purchased and used by the company. However, it is when we come to Scope 3 that the going gets tough.

With Scope 3, companies report on the indirect CO₂ emissions resulting from the business activities of other organisations in the value chain. These sources of emissions are not owned by the organisation in question, which is also unable to influence them directly. Examples include the emissions caused by the production or extraction of (raw) materials purchased and outsourced jobs such as goods transport. Indirect emissions caused by business travel in private vehicles and/or planes, financial investments, franchise and leasing contracts, and the use of the products sold also belong in Scope 3.

While Scopes 1 and 2 are fairly simple to define, the accurate measurement and mapping of Scope 3 emissions will be a formidable task and may lead to fraud or manipulation. Moreover, every business in the value chain is expected to report Scope 3, which is not only inefficient but will also result in the same emissions being counted more than once. Furthermore, as long as it is not obligatory, many businesses will not report Scope 3. And that is a shame because Scope 3 is precisely the missing piece of the puzzle in the race for a lower carbon footprint across the entire supply and distribution chain. A dearth of Scope 3 reporting also means that businesses in industries such as iron and steel, or in the chemical and petrochemical industry, are labelled as heavily polluting whilst the customers and consumers of these highly polluting components evade their responsibility.

The good news is that a solution to this reporting problem does exist. In a recent article, Robert Kaplan, the well-known Harvard Business School professor, talks about the introduction of an e-liability system, or in other words, a climate debt account. So how does it work?

What is E-liability?

The E-liability accounting system offers several advantages. It not only eliminates the duplicative counting of carbon emissions across your value chain, but it also reduces incentives for manipulation. In this ‘What is’ video, Professor Kristof Stouthuysen explains the concept of E-liability.

The idea is based on the way in which accountants calculate a business’s added value. In the case of a beer producer, for example, rather than estimating the prices paid by all the businesses in the value chain, you look at the value that they themselves add during the production of beer. In other words, we can calculate the gross added value by subtracting the cost price of the raw materials from the revenue. The same idea can be applied to the climate debt account.

For example, imagine that the beer producer orders its grain for beer in France. In order to produce and store grain, the French farm emits CO₂. This is predominately a Scope 1 emission. These total emissions are recorded in a climate debt account, which can be seen as an “accounting” debt owed by the farm to the planet.

When a transport firm employed by the beer producer comes to collect the grain, this transport firm will take over the climate debt (in proportion to the number of kilos of grain ordered) in its climate debt accounting. This outstanding debt will then increase further with the CO₂ emissions per kilometre driven. Once the grain has arrived at the beer producer, the latter takes over the climate debt accumulated by the transport firm into its accounting, subsequently adding the emissions generated by its own production. Ultimately, this process continues through to the end customer, who is given insight into the carbon footprint of the entire value chain.

What are the advantages of climate debt accounting?

With this new system, you avoid carbon emissions across your value chain being counted more than once. It also reduces opportunities for manipulation. For example, a business can no longer artificially limit its Scope 1 by outsourcing production. Moreover, a business can no longer profit from the underestimation of its climate emissions when it sells something because its own climate debt account will gradually rise. The opposite is also true: if the business were to overestimate the CO₂ emissions transferred to its customers, the customers would most probably go in search of less polluting suppliers.

Businesses can take further positive action to reduce their net outstanding climate debt, for example by switching to reusable energy and adopting a waste policy. You can also (legally) monitor the net balance of this climate debt account in the same way as you would monitor the entries in traditional accounting. Blockchain technology will play a significant role in ensuring that this accounting and auditing process runs smoothly. This technology allows for the reliable recording of Scope 1 emissions at every step in the value chain so that the successive climate debt transfers will indisputably equal the total Scope 1 emissions across the whole value chain.

And beyond CO₂ emissions alone, you could also apply climate debt accounting to other climate-polluting activities. For example, a social debt account could map the social debt that arises when businesses allow unsafe working conditions, child labour or money laundering. There is nothing to stop businesses from starting this climate debt accounting system now. I am certain that customers and investors are not the only ones who will value it: our planet will benefit too.

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