Carbon Diagnostics Methodology
Emmi believes a carbon price is the simplest mechanism to reflect a dollar-value risk associated with the transition to a zero carbon economy. As such, our methodology is entirely premised on carbon being given a price, and seeing how much of an asset’s value erodes as a result. We want this question to be answered on a mass-scale today, with data that is available today.
On this page, we will talk through our sequence of methodologies for completing that equation. We will use a fictional company to illustrate how the process plays out.
Say hello to Acme Steel Inc.
They’re a 6,000 person Steel manufacturer, based in Australia. Acme is a fictional company we'll use for our worked example, providing realistic yet rounded numbers.
Emmi’s methodology for emissions estimations allows a series of business metrics, like revenue and geography, to predict Scope 1, 2, and 3 emissions. We do this using Machine Learning. Our models are trained on 6,000 public companies that have reported and verified emissions, which can then extrapolate to correlation factors for any company in the world.
Carbon Emissions footprint estimations
Financed Emissions
Lets say Beta Super invested 5% of their $1billion super fund into Acme Steel. What is financed emissions of this investment?
Acme Steel Inc has an enterprise market value of $1.5billion, so the owned attribution of Acme’s emissions (or ownership) is 3.3%. Multiplying that attribution by Acme Steel Scope 1+2 footprint of 10.1million gives us 330,300 tonnes of financed emissions for Beta Super’s investment into Acme Steel. If Scope 3 is needed based on your regulatory standard, then the financed emissions would be 805,200 tonnes of financed emissions for Beta Super’s investment into Acme Steel.
Implied temperature alignment evaluates a holding’s emissions against established global temperature scenarios ranging between 1.5ºC to 4ºC. Emmi's method compares a company or portfolio's emissions to their fair-share of global emissions throughout the various temperature scenarios.
This is calculated using 5 equally weighted economic factors including Enterprise Value, Earnings, Total Assets, Net Assets and Market Capitalisation - that represent the economic activity of the company relative to the rest of the world's economy.
Temperature Alignment
Acme Steel Inc has an enterprise market value including cash (EVIC) of $1.5billion, market capitalisation of $8.3billion, Total Assets of $9.9billion, Net Assets of $-3.7billion and Earnings of $1.6billion. The worlds industrial economic activity is ~2550 bigger than Acme Steel, based on the same 5 metrics at global scale. With Acme’s emissions estimate of 24.4million tonnes, an Earth-scale Acme’s emissions would be 62 billion tonnes.
The budget to be aligned with a 1.5degC in 2023 world is 28 billion tonnes, 35 billion tonnes for 2degC and 40 billion tonnes for 4degC. That makes Acme steel over 4degC aligned since it’s producing 62billion global equivalent tonnes - much higher than the 4degC scenario.
Carbon Liability preparation
To be able to calculate a carbon liability, three methods are applied in sequence:
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The company’s economic activity is weighed relative to Global industrial economic activity, to understand it’s relative economic contribution.
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Given the relative contribution, we allocate a no-opinions* fair share of annual carbon emissions based on 1.5º, 2º and 4º scenario budgets - their “carbon budget”.
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Emissions estimates for the company are assessed against the carbon budget, to understand carbon budget overrun - “the gap”.
*What do we mean by no opinions? Emmi's baseline model apportions a global carbon budget equally based on economic activity, to every asset across industries and regions Adding your own viewpoints is an important part of our vision for Carbon Pro, see below for more detail.
What is the economic contribution of the asset in question to the world’s economy? Using a similar approach to the temperature alignment methodology, Emmi includes a much broader set of 12 economic factors that include revenue, valuation, debt, liabilities, dividends, PE, cash, EBITDA and much more, to assess the economic activity of an asset. These factors are used to quantify the carbon budget this company fairly deserves given the relative economic activity it generates in return.
Relative Economic Contribution
Based on certain climate scenarios, each year into the future the earth has a scientifically identified global carbon budget. Emmi allocates the global carbon budget of any given climate scenario across each year, using the economic contribution factor of the asset, as described above. We divide the global carbon budget equally based on a fair-share of global economic activity and value.
Based on Acme’s economic contribution, it receives a corresponding budget allocation within 2023.
In addition to their enterprise value, revenue and assets (see temperature alignment method above), Acme Steel Inc. has operating cash flow of $1.2billion, cash reserves of $1.5billion, dividends of $53million, P/E of 9, Total Debt of $870million and Total Liabilities of $3.7billion.
These financial fundamentals give Acme a proportional fair-share 'allowance' of emissions of ~22million tonnes per year under a 1.5ºC global budget.
Carbon Budget allocation
When a carbon budget has been allocated, the current estimated emissions for an asset are projected into the future, assuming no change to their carbon emissions. The delta between the allocated budget, and the company’s estimated emissions from today form a “carbon budget overspend”. We call this “The Gap” – the difference between their budget, and their actual emissions over time.
For every company, we project today’s emissions estimates into the future, to see how this gap widens over time, creating a cumulation of carbon overrun.
Calculating Acme's budget overspend is as simple as subtracting the annual budgets into the future, and charting that against their estimated emissions. So for 2023 the gap would be 24.4million tonnes - 22million tonnes or 2.4million tonnes gap. The cumulative overspend is calculated as the area over the budget, and under the emissions estimate.
Emmi now puts a price on carbon, in order to show the economic downside to “The Gap”. A number of company financial factors are taken into consideration in assessing the erosion of value based on the carbon price. This algorithm is intended to answer a simple question:
How much of this asset’s value, in todays terms, is eroded if there was a price on Carbon?
The carbon price for the world to be aligned with a 1.5degC scenario is $145 per tonne in 2023. Given Acme has an over-run budget of 2.4million tonnes, this implies a carbon liability of $348million. This carbon liability is deducted from the companies operating performance or EBITDA, so Acmes carbon-adjusted EBITDA is $1.6Bill - $0.348Bill = $1.252 Billion.
We use the EBITDA multiple as a quick way to re-value a company today or into the future. This is a financial ratio that compares a company's Enterprise Value to its annual EBITDA - for Acme that would be $8.2billion/$1.6billion = 5.125. So their new 2023 Enterprise Value would be expected to be $1.252billion x 5.125 = $6.42billion. In percentage terms, this equals (1 - 6.42 / 8.2) = 21.75% erosion of EV in 2023.
In 2030, the carbon price for a 1.5degC world has increased to be $218 per tonne while their fair-share carbon budget allocated has reduced to be 20million tonnes. Without any changes to Acme’s emissions (24.4million tonnes), their annual carbon cost is $960 million in 2030, leaving their carbon-adjusted EBITDA at $640million. Applying the same EBITDA multiple of 5.125 Acme’s new EV in 2030 is $3.28billion - which is a 60% reduction in EV from today.
Carbon budget overrun
Carbon Liability
Emmi's methodology for financed emissions is to use our carbon emissions footprint estimates, and apportion the percentage of those emissions to the financial institution based on the level of ownership of equity or debt of the asset. Our financed emissions methods follow the Partnership for Carbon Accounting Financials.
Acme Inc. has $10billion in revenue, is based in Australia within in the Materials sector with a capital expenditure of $500million and net property, plant and equipment value of $4billion. Based on these factors, Emmi estimates it has 8.6million tonnes of Scope 1 emissions, 1.5million tonnes of Scope 2, and 14.3million tonnes of Scope 3 emissions.
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Six asset classes
We have mapped this data process across six asset classes, to provide high coverage for multi-asset portfolios, with high-level rationale that holds true across assets. Each of our processes consider specific nuances of each asset class. For example Corporate Bonds pay special attention to the quality of loan, and model higher erosion for lower priority bonds.
Asset classes covered:
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Public Equities
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Private Equities
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Government debt
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Corporate debt
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Infrastructre
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Property
We have built Emmi’s modelling with flexibility at it’s core. The methodology described here is our standard configuration that we apply to first-time Carbon Diagnostics customers. We believe it provides a fantastic starting point for understanding your carbon liability, without needing to have detailed opinions on which industry may or may not see carbon pricing introduced first, and in which year that might happen. It also provides a solid baseline to defend against greenwashing, to have considered a "no opinions" version of the modelling.
Beyond this configuration, we offer an ability to re-run analysis using alternative perspectives, aligned with the popular NGFS scenarios. This is essential for TCFD, as a way of proving proper transition risk analysis across orderly and disorderly transition scenarios.
When you are ready, we believe that your ability to apply your viewpoint more precisely is necessary to providing insights that you can make decisions with, so over time, we will be adding configurability across four key areas:
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Applying a viewpoint on Carbon Pricing; across regions and sectors.
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Applying a viewpoint on carbon budget allocations; which sectors or geographies should get special consideration for carbon budgets and why
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Applying a viewpoint on footprint projections into the future, rather than using a “flat” forecast for every asset
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Applying a viewpoint on where and how liability might affect each asset or sector differently
This introduces an order of magnitude more optionality and possibilities to explore, which is why it forms a future product offering, Carbon Pro.
Applying your own viewpoint
Emmi believes a carbon price is the simplest mechanism to reflect a dollar-value risk associated with the transition to a zero carbon economy. As such, our methodology is entirely premised on carbon being given a price, and seeing how much of an asset’s value erodes as a result. We want this question to be answered on a mass-scale today, with data that is available today.
On this page, we will talk through our sequence of methodologies for completing that equation. We will use a fictional company to illustrate how the process plays out.