· 7 min read
We cannot improve something we do not measure. The effort to limit global warming to 1.5°C requires that we decarbonize our economy, and measuring emission levels and future levels is therefore paramount. Mitigating climate change requires investing and funding the right infrastructure. Luckily the most impactful solutions are based on proven technologies that are becoming more and more price competitive. Adoption of solar panels, wind farms, heat pumps, EVs, and energy efficiency systems are accelerating. BNEF recently estimated that we passed the $1.1 trillion mark in 2022 in funding for low carbon energy investments. Although an important milestone, the figure is way below the investment required. The world has finite resources and we must fund what is impactful, to cut our emissions by half by 2030 in the most efficient way.
Therefore, it is not enough to quantify dollar spending alone, we also need to quantify the impact of each solution.
All greenhouse gases are not the same, so definitions are key
In climate change there are three paths to carbon neutrality: avoided emissions, abated emissions, and sequestration. The best way to reduce greenhouse gases (GHG) in the atmosphere is by not emitting in the first place. That can only be secured via abatement or avoidance. But given the size of the problem, abatement and avoidance are not enough and sequestering GHG already in the atmosphere is also crucial. There is still a lot of confusion on terminology, so let’s confirm definitions. Avoided emissions refer to a material reduction in emissions from an activity as a result of its replacement by a much lower-emission solution. Renewable energy replacing coal fired power plants and electric vehicles (EVs) replacing internal combustion engine cars (ICEs) are two key cases. Estimating the Potential Avoided Emissions (PAE) from a ‘replacement’ solution is vital, as avoided emissions is the most transformative and therefore impactful climate change mitigation measure. Abated emissions refer to emissions reduced through actions effectively equating to “less harm”. For example, a cement company that starts to use a more efficient clinker, or a fertilizer plant that reduces the use of fossil fuel in the production of ammonia are doing “less harm”. Lastly, sequestration covers activities that capture and store CO2e from the atmosphere. This can be via nature based solutions (NBS), of which trees remain the best “technology” to absorb CO2 through photosynthesis, or artificial, for example when CO2e is captured from power plants and stored underground. Critics of engineered sequestration (and NBS as well) worry that counting on sequestration gives a “license for business as usual”, allowing high emission industries to continue emitting heavily.
What solutions would be most relevant to take the planet to carbon neutrality by 2050 is a question that is much debated. I have had the privilege of speaking to several leaders in the field and I think it is fair to say that they all have strong views on the most relevant path. Dennis Pamlin, the mind behind Mission Innovation’s Avoided Emissions Framework, believes that we need a step function change, which only really transformative innovation can create. Avoided emissions would therefore be the most relevant path to carbon neutrality. Paul Hawken, the architect of Project Drawdown and the more recent Project Regeneration, sees nature as a fundamental aspect to get to the 2050 target, so believes sequestration plays a key role. Al Gore’s Generation fund focuses on abatement, believing that cleaning up the current high emission industries is crucial. In reality, all three paths are needed; what must be done is to quantify the impact of each. That is why banks have a key role to play in measuring decarbonization impact.
What banks and financial institutions currently have to disclose
CPI’s Landscape of Climate Finance shows the sources and uses of climate finance. In its most recent version, CPI’s landscape shows that commercial lenders, companies, multilateral development financial institutions and national ones are the key lenders to mitigation and adaptation projects. Tracking investments in volume is fundamental, but not enough.
Banks are already subject to mandatory climate change disclosures, according to their jurisdiction. For example, larger European banks (with over 500 employees) are under the EU Non-Financial Reporting Directive and are required to cover a range of ESG issues in their annual reports, including climate change. The mandatory disclosures include information on risks and outcomes related to climate change, and data on the bank's impact on the environment. There are also voluntary disclosures, such as the Task Force on Climate-related Financial Disclosures (TCFD) covering financial risks to banks that are climate related.
The most relevant information that lenders could provide is a full and detailed map of what type of project or solution they financed according to the three categories described above. For example, a backward-looking disclosure on the amount of funding (equity and debt) provided to projects that abate emissions in fossil fuel-intensive industries (e.g. cement, fertilizers, plastics, steel), that avoid emissions (from renewable energy, to clean energy storage, to recycling, green transportation, etc), and that sequester CO2e. It would also be relevant for them to disclose their funding towards climate change adaptation. In addition, financial institutions should openly disclose their funding of fossil fuel projects (from oil & gas exploration and production to coal). As mentioned before, the volume of funding in this level of detail is critical information to disclose, but is not enough. Financial institutions should also estimate the impact of all of their funding using the common metric of megatons of CO2e. How many tons of CO2e were not emitted in the first place, or will be able to be sequestered given the projects that were funded? When will that CO2e take place? With those figures, analysts would also be able to quantify $/CO2e and it will become very clear what are the solutions that cost the least and impact the most. We refer to these metrics as Time Value of Carbon and Carbon Returns.
A new taxonomy to accelerate change
For banks to show the data that really matters, a new taxonomy needs to be in place. Zoom is not a software company, but a telepresence solution that enable users to replace high emission trips with video calls. Similarly, Beyond Meat is not a mere packaged food company, but a plant-based diet alternative that allows consumers to satisfy craving for burger-tasting meals made with much lower emissions. A Tesla car, particularly one charged directly from a renewable source of electricity like a solar rooftop, takes a passenger from point A to point B with much lower emissions. Tesla is not just an automaker, but an EV producer. To identify the new solutions that replace business as usual (BAU), we need to classify the products and services accordingly.
We have developed a new unique taxonomy for the companies that are working to decarbonize the planet. We have mapped out over 60 solutions, across 24 segments and 79 sub-segments. They are mostly in the “avoidance” category, but we have also mapped out the most relevant “abatement” (less harm solutions), and “sequestration.” We have also classified the key adaptation investments, that although not reducing GHG directly are also key solutions in need of proper funding.
Climate change and energy transition are infrastructure problems, and capital markets and financial institutions play a fundamental role in funding the needed projects. With the right investments we can solve two problems in one go – fight climate change while developing cheap and sustainable energy sources. As the adage goes, if it gets measured it gets managed.
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