Carbon Liability preparation
To be able to calculate a carbon liability, three methods are applied in sequence:
The company’s economic activity is weighed relative to Global industrial economic activity, to understand it’s relative economic contribution.
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”.
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
Say hello to Acme Steel Inc.
They’re a 6,000 person company, based in Australia.
Acme is used throughout as a worked example.
We calculate a company’s requirements to reduce carbon emissions by assessing key company financial metrics against carbon emissions, and compare that to key global economic metrics (such as GDP, global wealth and global debt) against global carbon budgets specified in the IPCC 1.5º, 2.0º and 4.0º scenarios.
We process each of our five economic factors of the asset, weighing them against carbon emissions to assess how they compare to a global carbon budget.
Our five factors are:
1️⃣ We look at the scaling of that factor for Acme vs. the Global metric (e.g. GDP for Earnings) to figure out a multiplier.
2️⃣ We scale up Acme’s emissions based on the multiplier of the factor, as if Acme was the economy. We now have earth-scale Acme emissions, as determined by that economic factor.
3️⃣ We look at how Acme’s earth-scale emissions measure up against IPCC 1.5º, 2.0º and 4.0º C scenario global carbon budgets, to understand their emissions reductions requirements as a % of the global carbon budget.
4️⃣ We finally scale down the earth-scale carbon budget overspend to get Acme’s actual reduction requirements, based on that factor.
Each factor results in a slightly different reduction requirement, which are then combined with equal weighting to create a single number. We use this to indicate tonnes of C02 that needs to be reduced by this specific company, to be aligned with the IPCC 1.5º, 2.0º or 4.0º scenario.
Each different factor will consider a nuanced part of the asset, for example an asset’s value is not just determined by the level of revenue it generates but also the size of its underlying assets and liabilities. Measuring these factors together indicates their economic value, as part of assessing a reasonable carbon budget it should be allocated.
For our example, Acmes Scope 1 carbon emissions to earnings is $1,163 per tonne of carbon. The global benchmark for a 1.5°C scenario is $3,571. Since Acme's rate is lower, they need to increase the amount of earnings per ton to align with a 1.5ºC scenario, which requires reducing their emissions by 67%. We calculate those requirements and allowances across 5 economic factors across Scope 1, 2 & 3 to gain a comprehensive understanding of the company's reduction requirements.
When considering reduction requirements for temperature alignment, we assess across all 3 scopes at once - being under-budget in Scope 1 means it is possible that Scope 3 can be a little bit over-budget and still be aligned to a certain temperature scenario. This makes these reduction requirements more scientifically accurate.
This section is a part of both Temperature Alignment and Potential Carbon Liability. If you have already read it, feel free to skip past.