27 January 2010
Utility firms in the UK could soon have to publicly report their company-wide greenhouse gas emissions. The Climate Change Act 2008 sets a deadline for the UK Government to introduce mandatory reporting of emissions by companies by April 2012.
But pressure is growing for carbon reporting to be required within less than two years. In January, a group of UK institutional investors, companies and over 50 Members of Parliament backed a letter by the Aldersgate Group calling for the Government to introduce mandatory carbon disclosure as soon as possible. When this happens, firms will have to report emissions in their Directors' reports under the Companies Act 2006, which implements an EU-wide requirement for large companies to report environmental key performance indicators where appropriate.
At a facility level, combustion installations covered by the EU Emission Trading Scheme (EU ETS) must already report carbon dioxide emissions to regulators in line with legally binding EU guidelines (Commission Decision 2007/589/EC). Facilities with a rated thermal input above 20 MW must report verified "greenhouse gas emissions occurring during the exothermic reaction of a fuel with oxygen", excluding emissions associated with heat production or electricity imported from other installations. The scheme covers carbon dioxide emissions only, and will continue to exclude other energy industry greenhouse gases such as methane in its third phase from 2013.
In the broader utilities sector, over 20 water and waste firms will have to report their carbon dioxide emissions from energy use to the Environment Agency under the UK Carbon Reduction Commitment (CRC) Energy Efficiency Scheme, which starts in April 2010.
Risks from incorrect reporting
Failing to comply with mandatory reporting requirements could be costly. Companies that incorrectly report annual CO2 emissions under the CRC could face fines of up to £45,000 a year. UK operators under the EU ETS who make false or misleading statements on material issues could be fined or imprisoned, while underestimating emissions in relation to permits could lead to financial penalties. Under the Companies Act 2006, directors who provide false or misleading statements in reports, or fail to make a required disclosure, could be fined and be liable for any related losses. A robust, clear and shared disclosure framework is important for compliance.
The need for clear reporting standards and guidelines and robust data will be more and more important if market-based instruments are to help achieve national emission reduction targets under a future global climate change deal. A solid CO2 disclosure framework is essential for the efficacy of cap-and-trade schemes, planned in countries including the United States, Australia, South Korea and Japan. This was demonstrated during phase 1 of the EU ETS, when inadequate data led to an over-estimation of emissions, which in turn caused allowances to be over-allocated and the carbon price to collapse.
Clear reporting is also essential from an investment perspective. Institutional investors and fund managers are increasingly assessing exposure to carbon risks and opportunities in their portfolios, particularly in Utilities investments. Carbon efficiency - emissions per £ million in revenue or per kWh - is now taken into account in some asset pricing models.
Accurate data is important as incorrect carbon disclosures could affect a company's ability to raise capital. For instance, ratings agency Standard & Poor's now includes carbon in assessments of the future cash flows of EU power companies and related credit risks. So far, only UK coal-fired power generator Drax has faced a major downgrade due to expectations of higher carbon costs in 2012, causing it to change its capital structure. Drax obscures its potential exposure to carbon costs in financial reporting by disclosing expected CO2 emission allowance requirements in TWh-equivalents rather than in tonnes, which investors could more easily incorporate into carbon pricing models. International accounting bodies are currently developing guidance on accounting for emission allowances under trading schemes.
Different accounting methods used by European utilities
Mandatory reporting guidance under the EU ETS takes account of the most widely-recognised international corporate accounting and reporting standard - the Greenhouse Gas Protocol, developed by the World Resources Institute and World Business Council for Sustainability Development. The GHG Protocol underpins most GHG reporting standards, including the International Standardisation Organisation standard on quantifying and reporting GHG emissions at an organisation level (ISO 16064). The GHG Protocol informs the sustainability reporting framework developed by the Global Reporting Initiative (GRI). According to the network-based organisation, its framework was adopted by about a 170 utility companies in 2008, including RWE, E.ON, Energia De Portugal, Iberdrola, Enel, and EDF.
The GHG Protocol also underpins the UK Government's voluntary carbon reporting guidance - Guidance on how to measure and report your GHG emissions (September 2009), which is likely to inform future mandatory reporting requirements in the UK. From a compliance perspective, companies that have a good understanding of how to collect, monitor, disclose and manage their GHG emissions in line with voluntary carbon reporting standards will be better positioned for new mandatory carbon disclosure requirements.
The GHG Protocol is founded on five core principles: relevance, completeness, consistency, transparency and accuracy. Unlike the EU ETS, the GHG Protocol covers six greenhouse gases, including sulphur hexafluoride released in electric transmission and distribution equipment. The Protocol identifies clear organisational and operational boundaries for allocating accountability for emissions. To avoid double counting, it distinguishes between emissions from direct sources (Scope 1) and from indirect sources - purchased electricity (Scope 2) and other activities not owned or controlled by a company (Scope 3). Scope 3 emissions are typically from suppliers or products in use.
Difficulties and pitfalls
Although the GHG Protocol sets out a clear framework, applying it to a utility company's activities can be complicated. Each sub-sector has specific issues and peculiarities, and individual companies might find it challenging to classify activities against categories identified by the Protocol. The GHG Protocol includes an appendix that power companies should use to disclose emissions.
Despite the available guidance and enormous public and regulatory pressure on utility companies to disclose emissions, environmental data provider Trucost has found that many utility companies still struggle to provide accurate CO2 emissions data. One of the main problems is properly allocating emissions into the correct scope, given the high number of players involved in the electricity supply chain: generators, traders, distributors, transmitters and final customers. For instance, utilities usually produce the electricity they consume so an overlap of Scope 1 and Scope 2 emissions could be problematic. Another challenge is the classification of emissions linked to electricity purchased from other operators to resell to end customers. The GHG Protocol clearly states that these emissions should be classified under Scope 3, but power companies often disclose them under Scope 2. Trucost recently spotted the problem in reporting by the German power firm RWE AG, which usually provides comprehensive and good environmental disclosures. However, the company mistakenly reported 70 million tonnes of CO2 under Scope 2 to the Carbon Disclosure Project (CDP), an organisation that collects climate change information on behalf of a group of investors. This type of mistake could cause investors to over-estimate power companies' potential exposure to carbon liabilities.
Gas suppliers face a challenge in reporting methane emissions from natural gas leakage. For instance, the Germany-based utility giant E.ON AG only reports CO2 emissions from electricity generation in its latest environmental report, without providing information on methane emissions from its wide natural gas production, storage and distribution network. E.ON's natural gas business segment generated more than €27 billion and, according to Trucost estimates, 6 million tonnes of greenhouse gas emissions measured as their carbon dioxide equivalent (CO2e) in 2008. Although methane can represents a relatively small share of a company's emissions, it should be disclosed alongside GHGs from electricity generation to provide a more comprehensive picture of a company's emissions profile.
Trucost data for companies and investors
Setting up systems to properly collect, disclose and manage CO2 emissions can be resource-intensive. Trucost collects data on utility companies and cross-checks emissions qualitatively against the GHG Protocol. It also double-checks emissions data quantitatively against its unique database, developed over the past 10 years. The input-output model identifies the carbon profiles of companies in more than 460 different sectors and analysts use it to help identify potential anomalies in company reporting.
Trucost's database, which includes emissions of pollutants such as sulphur dioxide and particulates, can also be used to benchmark the carbon and environmental performance and disclosure of a company against its sector peers. Trucost database covers the largest 175 public listed utility companies worldwide and has data that is disclosed or derived from information such as fuel use for about 75% of them. The wide coverage and robustness of its data combined with the specialist knowledge of its analysts puts Trucost in a unique position to help companies start or strengthen their monitoring and reporting of environmental impacts. Trucost provides a cost-effective service for companies that are measuring their GHG emissions for the first time, or are developing the resources and knowledge to improve reporting. Companies and investors also use Trucost's consistent, normalised and standardised emissions data to help compare company environmental performance with sector averages, and to help identify potential winners and losers under regulatory constraints.