Reducing your carbon footprint doesn’t always result in going green

As investors focus ever more attention on climate change, a growing number of reduced–carbon investment strategies have become available. But while reducing one’s carbon footprint might seem like a great way to go green, it turns out that’s not always the case.

Green energy still has a carbon footprint

The complicating factor here is that green energy is still energy. Producing energy is carbon–intensive, so green energy companies inevitably have larger direct carbon footprints than, say, banks or tech firms or retailers.

We see this in the chart below, which plots the green energy rank and the carbon footprint rank of the 1641 companies in the MSCI world index as of December 31, 2016:

Relative carbon footprint rank vs green energy score rank

Source: Russell Investments, Trucost as of December 31, 2016

The majority of companies are not involved at all in green energy and are tied at the lowest green energy rank of 62. The interesting thing is that the remaining 61 companies that do produce renewable energy are high carbon emitters. In fact, not even one of these companies is ranked in the top 1000 for carbon footprint.

What this means is that a simple decarbonization strategy based purely on reduction of emissions is likely to exclude renewable energy production along with non–renewables. It does produce a lower carbon footprint, but it’s not going green.

This is why we think it’s better to take the green energy score into account in building a reduced–carbon portfolio. Our green energy score tells us the percent of a company’s total energy production coming from renewables. Incorporating the score would mean, for example, that we’d be more likely to underweight company A in a reduced carbon portfolio than we would company B, because company B has much higher exposure to renewables.

That’s one of the changes that were made earlier this year in Russell Investments’ approach to running reduced carbon portfolios. The other main changes made at that time were an explicit exclusion of companies with more than 20% of revenues coming from coal (on the grounds that coal is the least efficient fossil fuel in terms of carbon emissions) and the incorporation of broader ESG scores into the selection methodology (to ensure that the approach does not compromise wider sustainability goals.)

Measuring the carbon footprint

What may seem like a minor issue because it relates to only a handful of companies is actually a big deal. Of course, energy that is produced—whether the energy is green, brown or grey¹ —is produced in order to be used by other companies. So while there are fewer than 100 companies involved in energy production, this handful of companies is producing the energy is being used by ALL companies.

The measure of carbon footprint that is used above is based only on direct emissions (generally referred to as scope 1 emissions) plus electricity consumption (scope 2), relative to a company’s total revenue. So what we are monitoring with our green energy score is not just the direct emissions (scope 1) of the energy producers but also the source of a huge amount of everyone else’s electricity (scope 2). This is a small example of understanding the ultimate impact of a business. In order to measure the ultimate impact of all business, we would need what is referred to as scope 3 emission data. Scope 3 refers to the complete carbon emissions of a company’s value chain.

Scope 3 emission data is much more complicated to calculate because it involves not only identifying a company’s upstream and downstream activities but then assigning carbon emissions to them. Unlike the Scope 1 and 2, where we are seeing a lot of companies reporting their footprint, very few report on Scope 3. At this stage, it’s not reliable enough for us to have confidence in incorporating it into our methodology. We will continue to monitor the availability and robustness of this data, however, since it may at some point permit further fine-tuning of our approach.

The changes to our approach described above highlight that incorporating climate change into a portfolio remains a relatively new field of investment. It’s going to keep evolving. As more data becomes available to investors, and as thinking develops, we expect to see continuing enhancements to the leading decarbonization approaches in the coming years.