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The geometry of net zero: an accounting conundrum waiting to happen

Emissions accounting is often used as a tool to measure progress on the route to net zero, but such methods can be inconsistent, inaccurate and imply that climate change can be reduced to a book-balancing process. As the investment opportunities surrounding climate change proliferate, it is existentially vital that investors defer to the science.

  • Even if the entire global energy supply were to transition to renewables tomorrow, this would not be net zero
  • If climate impacts cannot be treated as smooth functions then the arithmetic of net zero cannot be treated as one-dimensional
  • Sustainable investment is about operating within dynamic, volatile and uncertain systems, not seeking comfort in fragile simplicity

The route to net zero has become clogged by the sheer number of economic actors jostling to control, define and limit the share of global emissions that they are deemed to be responsible for. This jostling is  ultimately characterised by the crude splitting up and attribution of regional and sectoral carbon budgets. In principle, this process may be a necessary and legitimate means of carving out one’s slice of the emissions pie but, in practice, it can simplify the drivers of climate change and opens the door to two carbon accounting processes that could prove very problematic in the future:

  1. Accounting for the ownership of emissions between corporate entities and financing entities;
  1. Accounting for which emissions fall within the activities (value chain) of a given corporate or real asset and are attributable to them.

Both of these processes could one day lead to cynical or erroneous action, and facilitate the deliberate or accidental manipulation of net zero claims. We might regard the jostling of the financial sector to splice up and fix emissions in this way as a kind of carbon exchange rate mechanism. In time, such practices could give rise to the kind of accounting scandals that the finance sector (and the media) is all too familiar with. The consequences of a Black Wednesday in the ‘carbon markets’ would have impacts we likely cannot currently quantify.

Bad mathematics

Carbon budgets are considered to represent the bottom line of net zero. While carbon offsetting may feel like a stable science, the inconvenient truth is that decarbonisation pathways are neither static nor predictable. They are, in fact, in constant flux – the relationship between sector-level carbon budgets is fundamentally indeterminate. Each sectoral carbon budget is ultimately dependent on the budget of every other sector, at all times – and carbon budgets themselves are contingent on a number of uncertainties that persist when modelling the physics of global warming. Treating a single sector-specific decarbonisation target as a static and predictably linear process is  akin to a currency exchange trading on the basis that the gold standard is still in place, and even that is to understate the error.

Even if the entire global energy supply were to transition to renewables tomorrow, this would not be net zero

Robert Hall

Associate Director - ESG, Impact and Innovation

It is this uncertainty – alongside the layering of various carbon accounting processes between the real economy and financial services – that enables specious claims of net zero ‘alignment’ and the outright misunderstanding of how carbon offsetting is achieved.

Earlier this year, Mark Carney pronounced that Brookfield Asset Management was effectively operating at net zero because its renewable energy portfolio balanced the emissions of its non-renewables portfolio1. Days later he was forced to back-peddle on the claim on grounds that it simply wasn’t accurate. This incident illustrates the deeply concerning but alarmingly common and long-lasting fallacies that surround the concept of carbon offsetting.

Along with Carney, other leaders in the space – including Nobel Prize-winning economist William Nordhaus – have made gaffs by assuming that the mathematics of climate change is static or linear. Economic damage analyses, like that created by Nordhaus, are generally ‘equilibrating’,  they use today’s climate dynamics to model tomorrow’s, and imply a smooth and continuous distribution without sudden change, disruption, or fundamental shift (also known as ‘tipping points’). And, (in)famously, they may massively underestimate the economic impacts of climate change by assuming that only activities which cannot be undertaken in spaces which can be air conditioned are likely to see productivity levels fall!2

Renewables do not ‘balance out’ non-renewables

Uncertainties surrounding a myriad of warming relationships in the natural world (including terrestrial, atmospheric and oceanic), remain a question of intense debate. Experts are similarly yet to agree on the precise quantities, timing and location of sources of emissions and emissions reduction. It is within – and not around - this uncertainty that the responsible fiduciary operates.

What is not a matter of debate is that demonstrable and additional emissions removal is the only offsetting counterbalance to current and future emissions. It is not correct to suggest without qualification that renewable energy already being generated offsets for emissions from non-renewable primary energy or from emissions from final energy use.

If climate impacts cannot be treated as smooth functions then the arithmetic of net zero cannot be treated as one-dimensional.

Notionally balanced energy production and consumption does not equal net zero emissions – in other words, not all gigajoules are created equal. Under this false logic, an investor could finance as much new fossil-fuel powered electricity generation as they could match with wind turbines without deviating from net zero.3

Even if the entire global energy supply were to transition to renewables tomorrow, this would not be net zero. An investor’s geographically and technologically diverse renewable energy portfolio cannot be treated as a like-for-like equivalent to the emissions of its unequally geographically and technologically diverse non-renewables portfolio.

It is too simplistic and wrong to think of renewables and non-renewables as being on either side of some sort of weighing scale and balance them out. Greenhouse gases and climate change are natural scientific phenomena, not discreet units to be delineated on a balance sheet.

Renewable energy projects are not zero emission

This is the stark reality: net zero cannot be achieved through ‘greening’ the entire energy system at its current output nor by offsetting emissions at their current rate of increase. Absolute emissions must be reduced. The quicker they fall and the sooner emission reductions are ‘designed in’ to all economic activity, the more economically efficient it will be. Legal, regulatory and systemic-risk parameters can now be quantified with sufficient certainty that to fail to do so could well be construed as a breach of fiduciary responsibility. This has not yet struck home for many investors.

The assertion that 'claiming renewable energy holdings can be used to internally offset other portfolio emissions is akin to asserting that 0 + 2 = 0',  has been repeated often of late to much mirth. It is, however, more accurate to say it is akin to asserting that 0.5 + 2 = 0, because crucially renewable energy projects are not zero emission. ‘Embodied’ emissions occur across the full lifecycle of energy infrastructure projects (and operationally zero emission buildings), most notably in the extraction of the raw materials from which they are constructed and the construction process itself. A 200-metre concrete hydropower dam is not carbon neutral on the day you switch it on.

Net zero presents a range of investment opportunities

Net zero decarbonisation can be modelled as a series of  asset management decisions with its own financially and economically efficient frontier and return opportunities, not a rhetorical device or necessary sunk cost.  A comprehensive net zero pathway, properly understood, presents a range of investment opportunities within and outside of existing portfolios for all investors. 'Real' offsetting itself (or ‘sequestration’) – where it is undertaken with reference to the dynamic complexity of climate science, 100% additionality and a holistic consideration of nature and local communities - is one such investment opportunity. This approach enables us to offer our end investors the only science-based and fully auditable (and most economically efficient) mechanism for removing their emissions from the atmosphere and reaching net zero.

Sustainable investment is about operating within dynamic, volatile and uncertain systems, not seeking comfort in fragile simplicity.  The route to net zero is not a straight , nor a winding road; it is a horizon, to be handled humbly and with an approach firmly based in natural science, not spreadsheet accounting.

  1. 1Carney’s stumble at Brookfield intensifies focus on ‘net zero’ claims, Financial Times, 9 April 2021
  2. 2Steve Keen (2020), ‘The appallingly bad neoclassical economics of climate change’, Globalizations
  3. 3For equivalent examples of this dualism, see Alova (2020), ‘A global analysis of the progress and failure of electric utilities to adapt their portfolios of power-generation assets to the energy transition. Nature Energy, pp. 920–927. Alova regresses an asset-level global dataset of more than 3,000 utilities between 2001-2018 in order to evaluate the underlying dynamics of their ‘transition’ from fossil-fuelled capacity to renewables. She found that: ‘[t]hree-quarters of the utilities did not expand their portfolios. Of the remaining companies, a handful grew coal ahead of other assets, while half favoured gas and the rest prioritized renewables growth. Strikingly, 60% of the renewables-prioritizing utilities had not ceased concurrently expanding their fossil-fuel portfolio, compared to 15% reducing it. These findings point to electricity system inertia and the utility-driven risk of carbon lock-in and asset stranding.’

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