What is GHG Accounting? Market-based mistake
Installment N.4
Preface
This installment extends the discussion from installment N.3 on emissions allocation in GHG inventories. Unfortunately, you will need to read the prior installments in this “What is GHG accounting?” series prior to reading this one on market-based approaches.
- Turning away from LCA (Installment N.-1)
- Furnishing definitions (Installment N.1)
- Fitting to purposes (Installment N.2)
- Allocation rules (Installment N.3)
- Further Thoughts on Responsibility & Causation (Installment N.3 bis)
A coming installment will address a missing piece of the GHG accounting puzzle, which is a framework for how companies can aggregate and report the impact of ambitious GHG mitigation interventions that are made in, or beyond, their value chains. These mitigation interventions would occur beyond the proposed more delimited GHG inventory boundaries for indirect emissions, as described in this series. We are also developing examples for select sectors to illustrate both the reformed GHG inventory boundaries and the application of a mitigation intervention accounting framework to inform the ongoing GHG Protocol update process.
Introduction
Market-based approaches are used for allocating emissions in some GHG reporting frameworks, most commonly represented by the GHG Protocol’s market-based approach for Scope 2 emissions reporting of corporate “green power” purchasing claims (Brander et al., 2018; Brander and Bjørn, 2023; Gillenwater, 2008a; Miller et al., 2022). These market-based approaches in GHG inventories are applying a type of financial allocation of emissions (see section “Physical vs. financial allocation”). I argue that physical GHG accounting, becomes physically meaningless, and therefore environmentally meaningless, when the allocation of emissions to accounting subjects is based on financial or contractual arrangements independent of physical connections between subjects and emission sources. For example, physical GHG emission inventories that include indirect emissions from the consumption of energy (e.g., grid electricity) should only allocate such emissions to an accounting subject, such as a company, if it is physically connected (e.g., via energy transfers) to the source of emissions, regardless of whether and what type of financial transaction or contractual arrangement was involved.[1]
In contrast, those advocating market-based approaches for GHG inventory accounting are effectively arguing that a financial exchange can substitute for a proven physical connection when allocating emissions to a company or other accounting subject. In other words, they are arguing that financial and contractual arrangements should be used to reallocate emissions from one company to other companies through transacting (i.e., buying and selling) emission factors. These financial and contractual arrangements typically involve some type of tradable environmental commodity, often referred to as an attribute or certificate.[2]
However, in most discussions on the use of market-based approaches in corporate GHG inventory accounting, it is far from clear they are actually addressing the question of how to properly allocate emissions to companies.[3] Instead of justifying the use of a particular tradable attribute or certificate by arguing how it appropriately allocates emissions to companies, it is instead more common for justifications to focus on how a certificate transaction, or the overall market for the environmental commodity, will incentivize actions that avoid emissions. In other words, the common justifications for market-based approaches treat the purchase of attributes or certificates as interventions.[4] So, are these emission attributes, certificates, and other market-based approaches to be treated as a proper claim to a specific emission factor for use in physical allocational GHG accounting (i.e., GHG inventories) or as a claim regarding the impact of an intervention (i.e., physical consequential GHG accounting)? If the former, I argue that it is inappropriate to use them for physical allocational GHG accounting because they are a mechanism for the allocation of emissions based purely on financial relationships (i.e., regardless of a physical connection). If the latter, then accounting for them is properly done through physical consequential GHG accounting methods (e.g., reporting of the avoided emission impacts of interventions by companies) separately from GHG inventory accounting. Advocates for any market-based approach must clearly select one or the other if they are conducting physical GHG accounting. Alternatively, there is nothing wrong with instead creating a synthetic scoring metric that mixes elements of allocational and consequential methods for a particular policy application. However, such a scoring metric is an example of “performance GHG accounting” that neither produces a measure of physical emissions to the atmosphere nor avoided emissions.
A key concept in understanding market-based approaches to account for indirect emissions in GHG inventories is the activity pool, defined as a common set of emission sources that physically serve (i.e., are connected to) an accounting subject (e.g., company) where traceability from the specific physical source of emissions to a specific accounting subject is not possible (Brander and Bjørn, 2023). The most well-known activity pool is a shared electricity distribution grid—along with the generators connected to it. But other examples include natural gas pipeline networks, agricultural and raw material commodities, and waste management systems used for the disposal of sold products. Because consumption of products or services by companies from an activity pool is from a mixture that cannot be differentiated with respect to its upstream or downstream processing, emissions are logically allocated based on the average emissions intensity (i.e., emission factor) of that pool.[5] Any other allocation rule would presume physical traceability exists, when in truth it does not, or would allow emissions to be reallocated between companies based on purely financial or contractual arrangements. Yet, proponents of market-based approaches argue that the inherent lack of physical traceability is why the use of financial and contractual arrangements to reallocate emissions within, and sometimes beyond, the pool’s consumers is justified.
Allocating emissions to GHG inventories or making avoided emissions impact claims—the two rationales for the use of market-based approaches—are often disconcertingly jumbled by advocates. This confusion in both the rationale and purpose of GHG accounting has propagated from the domain of grid-connected electricity and Scope 2 to the other activity pools and GHG Protocol reporting Scopes. This propagation already includes emerging certificate markets for contractual emission factors from the production or use of biomethane, steel,[6] coffee beans, palm oil, aluminum, aviation biofuels, freight transport, maritime shipping, and oil (Brander and Bjørn, 2023).[7] Some of these new certificate claims are already being applied to Scopes 1 and 3. [8],[9],[10]
If not limited to activity pools, then market-based approaches involving certificate and other market-based accounting claims—taken to their logical conclusion—would allow a company to effectively “purchase” emission factors for any source, and therefore “buy” the GHG inventory total of its choice. The resulting corporate GHG inventory reporting would then have no meaningful physical relationship to the direct or indirect emissions associated with a company’s physical operations. Limiting market-based approaches to specified activity pools curtails, but does not eliminate, this problem.
The purpose of physical allocational GHG accounting is to assign responsibility for emissions to subjects in a comparable and (time series) consistent manner. Its primary function is not to serve as an incentive mechanism for mitigation actions.[11] So, is there any role for market-based approaches in GHG accounting? Yes. Although, I argue that they have no role in physical allocational GHG accounting (e.g., GHG emission inventories) even in cases involving activity pools like grid-based electricity. Instead, they can properly have a role in physical consequential and performance GHG accounting. A well-designed certificate or other market-based mechanism can effectively create an incentive for GHG mitigation actions.[12] The avoided emissions impact of this mechanism can then be accounted for at two distinct scales by:
- Treating each certificate transaction as an isolated financial or contractual intervention by an individual company (e.g., a single power purchase agreement within a wholesale electricity market) with its avoided emissions impact physically quantified using a consequential accounting method;[13] or
- Performing the quantification of impact using a consequential accounting method at the larger scale of the aggregate certificate market, which would entail shares of the total avoided emission impact of the overall market over a set period being distributed to the participants in that market (e.g., based on shares of the environmental commodity retired by each company for a given vintage).
I would argue that GHG accounting at the second wider scale is in keeping with the fact that the actual impact of these certificate markets is only revealed at a market-wide scale (i.e., treats the overall environmental commodity market as the intervention). It also escapes the need to assess the impact—and additionality—of each individual issuance or transaction of certificates, replicating some of the challenges with emissions offset project crediting.
Quantifying the GHG impacts of interventions implemented via an environmental commodity market can provide valuable information to the users of corporate climate reporting. Specifically, it recognizes each company for their contribution to the overall impact of a given certificate market, which aggregates corporate investments for achieving a collective goal of avoiding emissions. But creating new marketplaces that instead focus on buying and selling emission factors leads to misleading physical emissions allocation results for GHG inventories.
The existing GHG Protocol corporate standard, as amended by its Scope 2 guidance, (Mary Sotos, 2015; WRI/WBCSD, 2004) is already an example of performance GHG accounting, and therefore is not an instance of proper physical allocational GHG accounting (i.e., it does not produce physical inventories GHG emissions and removals allocated to companies) (Brander et al., 2018). And now with the propagation of market-based approaches, the GHG Protocol is further opening a Pandora’s box of allocational and consequential GHG accounting hybrids for corporate reporting. Within the ongoing process to update the GHG Protocol corporate standard, it will be necessary to decide whether the future of the GHG Protocol is to serve as an accounting standard for producing physical GHG inventories that assign responsibility for emissions to companies, or as a broader corporate GHG performance scoring framework that combines multiple distinct forms of GHG accounting and other measures. Underlying this decision is the more fundamental question of what functions are GHG reports prepared in keeping with the GHG Protocol intended to serve.
Market-based accounting reform options
Table 1 presents three major options and several sub-options for reforming the current application of market-based approaches that currently attempt to allocate emissions to the GHG inventories of accounting subjects (e.g., companies). It also summarizes the application of each option specifically for the accounting of indirect emissions from the consumption of pooled energy (e.g., Scope 2 indirect emissions from consumption of grid-connected electricity), identifies the option’s corresponding form of GHG accounting, and lists some implications of each option and sub-option for GHG accounting more broadly (e.g., Scopes 1 and 3). By design, the table does not include any options that involve the use of marginal-type emission factors (EFs), as such marginal factors are intended for estimating avoided emissions and are not compatible with allocational physical GHG accounting (i.e., the property of additivity is violated if all subjects in a population claim the same marginal/avoided emissions rate in their GHG inventories).[14] Again, hybrids of allocational and consequential GHG accounting methods produce incoherent results that are a mix of physically occurring emissions and avoided emissions (Brander, 2016; Brander and Wylie, 2011; Plevin et al., 2014; Sandén and Karlström, 2007; Stridsland et al., 2023).
If our purpose is to produce a physical accounting of GHG emissions, avoided emissions, or both, then I argue that the correct option for the application of market-based approaches is to forbid market-based emission factor claims and require the use of average emission factor values for activity pools and then separately apply a physical consequential GHG accounting framework for avoided emissions from interventions, with the estimation of aggregate certificate market impacts. These aggregate impact estimates would then be assigned to the market’s participants based on the share of certificates of a given vintage they held (i.e., option 3.b.ii in Table 1). This option both avoids the problems with the allocation of emissions based on financial factors that underly market-based approaches to GHG inventory accounting and properly recognizes the substantiated avoided emissions impacts that result from market-scale interventions. It also logically treats an organized environmental commodity market in aggregate as an intervention rather than impractically assuming that the impact of each transaction in that market can be individually quantified in isolation.[15]
As a general principle for the allocation of indirect emissions in physical GHG accounting, if traceability through physical connections is possible, then emissions from the specific emission source should be quantified and allocated to the connected accounting subject. If the indirect emissions result from consumption from an activity pool (i.e., traceability is not possible) then accounting subjects should use an emission factor based on the average emissions intensity for that pool. Such activity pools can either be inherently untraceable (e.g., grid electricity, pipeline gas) or practically untraceable (e.g., commodity aluminum billets) (Brander and Bjørn, 2023).
Electricity and other pooled energy carriers (e.g., steam and chilled water) are unlike most other products consumed by companies because each unit is produced and consumed approximately simultaneously and are only occasionally stored (Curran et al., 2005; Soimakallio et al., 2011). For such commodities, the activity pool average emission factor should also consider the timing of the accounting subject’s consumption. For grid-connected electricity, the mix of generation resources supplying a defined grid pool may vary substantially by time of day and across days and seasons (Blizniukova et al., 2023). Therefore, the allocation of indirect emissions from the consumption of electricity should use grid average emission factors that vary in time at a much higher temporal resolution than the current practice of annual grid average emission factors.
Miller et al. (2022) found that annual average grid factors can lead to biased, and therefore inaccurate, Scope 2 emission estimates compared with hourly average grid factors (i.e., under or over estimates of up to 35%). Further, these biases are expected to increase as the fraction of variable generation (i.e., renewables) supplying electric power grids grows.[16] A shift from the current practice of using annual average grid emission factors will require improved data collection. For jurisdictions that lack data collection systems for the timely release of generation unit dispatch and emissions, hourly average grid emission factors can be approximated based on interpolation models combining the available lower resolution data and expert assumptions of expected generator dispatch patterns. Similarly, for companies lacking hourly electricity consumption data, simple models can be used to apportion monthly or annual consumption data based on reasonable load assumptions and corporate operational data and knowledge. The increasing deployment of electric “smart meters” diminishes the need for such apportioning models. However, further research and coordination on GHG accounting rules are needed to develop more standardized activity pool boundary definitions for grid connected electricity in each jurisdiction.
Table 1. Options for reforming the use of market-based allocation of emissions in GHG accounting
| Market-based reform option | Scope 2 version of option | Implied form of GHG accounting* | Implications for GHG accounting** |
|---|---|---|---|
| 1) No reform - status quo. | Status quo dual reporting of location and market-based approaches as elaborated in Sotos (2015). Various contractual arrangements used to claim to be “buying green power”, both of which are treated equally in corporate GHG inventories. See Brander et al. (2018) for an elaboration of existing problems with status quo. | Performance GHG accounting because allocation of emissions is justified using an ambiguous mix of financial factors and consequential thinking. Does not meet the definition of physical allocational or physical consequential GHG accounting. | Continued ambiguity regarding the acceptable use of market-based claims (e.g., certificates) for allocation of direct and indirect emissions (i.e., Scopes 1, 2, and 3). Some companies mix intervention impact (consequential) estimates into their GHG inventories. Accounting subjects (e.g., companies) and other actors are allowed to invent their own GHG accounting rules and make emissions and emissions impact claims with little guidance or oversight, thereby leading to further lack of comparability between company reports. No differentiation in accounting rules between market-based interventions with no impact and those with substantial impacts. Neither credible physical allocational nor physical consequential GHG accounting is achieved through corporate reporting. Companies can increasingly “purchase” emission factors (EFs) for any emissions source (i.e., a company can simply “purchase its GHG inventory” and reported emissions trend). |
2) Restrict the use of market/certificate-based exclusive EF claims to cases where:
| Restrict the use of energy attribute certificate (EAC) based EF claims:
| Performance GHG accounting because exclusive allocation of emissions is justified using purely financial/contractual factors, and therefore does not satisfy the definition of physical allocational GHG accounting. Option 2c introduces a consequential justification for an allocation rule, and therefore could be viewed as a hybrid allocational and consequential method (i.e., performance GHG accounting).20 | (a,b) Market-based interventions with no impact and those with substantial impacts are accounted for as being the same (i.e., as avoiding all emissions from the source they are applied to). (b) Addresses double counting of emissions. (c) Mixes consequential methods into GHG inventory accounting and introduces causal (consequential) justifications for allocation in GHG inventories. |
3) Forbid market/ certificate based exclusive EF claims and require use of average EF values for activity pools:
| Allow the use of location-based approach only in corporate GHG inventory reporting (ideally with improved grid average EFs including better temporal resolution, more representative population of generators for grid averaging, and more timely release of grid average EFs) and eliminate the market-based approach for allocational GHG accounting (i.e., emission inventories).
| Physical allocational for 3a and 3b and physical consequential GHG accounting for 3b, which are properly and distinctly reported. | (a,b) Elimination of market-based emission allocation claims from GHG inventories. (a,b) Elimination of the mixing of intervention impact (consequential) estimates into GHG inventories. (a,b) Forbids companies from “purchasing” EFs regardless of their physical connections to emitting processes. (b) Development of clear guidance on separate reporting of intervention impacts (i.e., avoided emissions), including aggregating estimated impacts across interventions. (b) Proper quantitative evaluation and reporting of market-based interventions according to their actual impact upon emissions (relative to no-intervention scenario). (b) Separate reporting of credible physical allocational and physical consequential GHG accounting results. (b) Avoided emissions estimates may be associated with emission sources within the inventory accounting boundary, but because reported separately through the use of different forms of GHG accounting, there is no double counting. |
| * See "What is Greenhouse Gas Accounting? Furnishing definitions" (N.1) for definitions of each form of GHG accounting. ** Letter codes in parentheses refer to the sub-option(s) in the first column that the bullet applies to. |
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A thought experiment on indirect emissions from air travel
A thought experiment that is useful for exploring questions on the role of market-based approaches for GHG accounting is to consider the case of allocating indirect emissions from commercial air travel where aircraft are fueled with a blend of fossil jet kerosene and a biofuel.
Imagine a plane that is fueled with a 10% blend (on an energy content basis) of biofuel. A passenger on a plane then wishes to pay a premium to the airline to exclusively claim the consumption of the biofuel for the purpose of reporting their indirect emissions from air travel. Table 2 steps through the allocation options that would and would not allow this passenger to make this exclusive claim for the purpose of physical allocational GHG accounting (e.g., reporting their corporate GHG inventory).[21]
Table 2. Passenger emission allocation options for aviation biofuel thought experiment
| Emissions allocation options | Proper physical allocational GHG accounting? |
|---|---|
| Simple activity pool average allocation: Every passenger on a plane is allocated an equal share of fuel consumption and resulting combustion emissions for both fossil and biofuel portions in the form of the EF for the blended fuel. | Yes. Physical connection present, no reallocation based on purely financial/contractual EFs. Analogous to the current Scope 2 location-based approach with annual grid average EFs for power region. |
| Advanced activity pool average allocation: Every passenger on a plane uses the EF for the blended fuel, but the amount of fuel allocated as indirectly consumed by each passenger is adjusted based on a tallied passenger mass (e.g., more mass of the plane dedicated to transporting a first-class passenger than an economy class passenger, as vehicle mass is physically connected to fuel consumption). | Yes. Physical connection present, no reallocation based on purely financial/contractual EFs. Analogous to the Scope 2 location-based approach with higher physical resolution such as hourly grid average EFs for power region. |
| Market-based allocation with physical connection: Passenger on a flight with blended fossil and biofuel pays a fee to exclusively claim biofuel consumption and use biofuel EF (i.e., not blended EF). Residual fuel EF assigned to other passengers. | No. Physical connection is present, but emissions are reallocated amongst passengers on flight based purely on financial/contractual EFs. |
| Market-based allocation without physical connection: Passenger on a different flight (i.e., not on the flight with blended fuel) pays a fee to exclusively claim biofuel consumption and use biofuel EF (i.e., not blended EF). | No. Physical connection is not present, and emissions are reallocated across passengers and across flights based purely on financial/contractual EFs. Ambiguous how to calculate and assign residual EF(s) across flights; similar to the challenge of assigning “null-power” emissions for Scope 2. |
Click here to read all the posts in the “What is GHG accounting?” series
Acknowledgments
I am thankful for the insightful comments from and discussions with my colleagues Matthew Brander (University of Edinburgh), Derik Broekhoff (SEI), Anders Bjørn (DTU), Keri Enright-Kato (GHGMI), and Tani Colbert-Sangree (GHGMI).
Recommended Citation
Gillenwater, M., (2024). What is Greenhouse Gas Accounting? Market-based mistake (N.4). Seattle, WA. Greenhouse Gas Management Institute, January 2024. https://ghginstitute.org/2024/01/31/what-is-ghg-accounting-market-based-mistake/
Endnotes
[1] One could argue that the GHG Protocol corporate standard (WRI/WBCSD, 2004) made a category error in its definition of Scope 2 by labeling it “purchased” power rather than “consumed” power. As a physical GHG emissions inventory should represent direct and indirect emissions from physical processes, such as consuming energy, whether or not a financial transaction was involved.
[2] Another more recent term is ”book and claim unit” (https://rsb.org/programmes/book-and-claim/).
[3] An example of a market-based proposal that does attempt to serve as a true allocation mechanism is the emissions “liability” scheme in which assigned responsibility for emissions is passed down from supply chain tier to tier as a form of bequeathed emissions debt (Marc Roston et al., 2022; Robert S. Kaplan and Karthik Ramanna, 2022, 2021; Roston et al., 2023). This scheme is almost surely impractical in a voluntary reporting context, as it would require near-universal participation (one company that opts out can break the chain of bequeathed liabilities). Further, it does not answer the question of how emissions are allocated when multiple downstream companies are involved (i.e., how to pass-down e-liabilities across many customers) as in Lenzen et al. (2007). It would surely also be a salesperson’s nightmare to have to bundle pollution liabilities with every sale.
[4] Terms such as “additionality” and “emissionality” are often used in discussions of market-based approaches to GHG inventory accounting. Emissionality is mostly unnecessary wordplay on the term additionality serving as another way to refer to avoided emissions impact in the context of electric power production. The concept of additionality should have no role in discussions of physical allocational GHG accounting (i.e., GHG inventories) (Gillenwater, 2012a). Although, Brander and Bjørn (2023) implicitly introduce the concept in their proposal for a market-based allocation approach requiring a determination of causation.
[5] The boundaries of these activity pools, along with their average emission factors, will ideally be spatially and temporally defined with the most resolution and/or representativeness that is practical. For example, in the case of indirect emissions from electricity consumption, average emission factors for the activity pool would preferably be hourly versus annual because electricity is typically produced and consumed simultaneously, leading to the emissions intensity of the activity pool changing with high frequency.
[6] https://corporate.arcelormittal.com/climate-action/xcarb/xcarb-green-steel-certificates
[7] Also see https://ghgprotocol.org/sites/default/files/Market-based%20accounting%20Survey%20Memo.pdf
[8] The U.S. EPA has commented on how certificates may be applied to Scope 3 corporate reporting (https://www.epa.gov/system/files/documents/2022-05/renewable_electricity_procurement.pdf).
[9] CDP has permitted companies to report “green gas” (biogas) certificates against their Scope 1 emissions (https://cdn.cdp.net/cdp-production/cms/guidance_docs/pdfs/000/000/415/original/CDP-Accounting-of-Scope-2-Emissions.pdf).
[10] Until it was amended in 2020, the GHG Protocol Scope 2 guidance (Mary Sotos, 2015) implicitly allowed market-based accounting of Scope 1 (https://ghgprotocol.org/sites/default/files/standards_supporting/List%20of%20Corrections%20to%20the%20Scope%202%20Guidance_0.pdf).
[11] However, such mechanisms or programs can use reported GHG inventory results for use in compliance or scaling such incentives (e.g., carbon taxes).
[12] Noting that the largest environmental commodity market in the context of corporate GHG disclosures—Energy Attribute Certificates or EACs used for Scope 2 reporting—is not well-designed and, as a result, extensive evidence exists showing it has had no significant effect in terms of avoiding GHG emissions (Bjørn et al., 2022; Brander et al., 2018; Brander and Bjørn, 2023; Galzi, 2023; Gillenwater, 2013, 2008a, 2008b; Gillenwater et al., 2014; Hamburger, 2019; Hamburger and Harangozó, 2018; Herbes et al., 2020; Hulshof et al., 2019; Mulder and Zomer, 2016; Nordenstam et al., 2018). When they are ineffective, market-based approaches can displace actions that truly result in avoided emissions.
[13] The impact could also be scored based on its physically quantified (or deemed) impact in a performance GHG accounting framework.
[14] See He et al. (2021) and Oats (2022) for examples of proposal approaching to using marginal emission factors in GHG inventory accounting. Both proposals violate the definitions for physical allocational GHG accounting.
[15] This approach works if the intervention is conducted through a homogeneous environmental commodity, such as some form of undifferentiated certificate. For example, the sustainable aviation fuel (SAF) industry is establishing such a certificate. In contrast, non-utility power purchase agreements (PPAs) are heterogeneous (i.e., few PPAs are alike) and would not be considered an environmental commodity (Backstrom et al., 2023).
[16] Miller et al. (2022) also found that using monthly average EFs does not seem to provide an improvement on annual average emission factors, indicating the greater importance of time of day versus seasonal variation in estimating Scope 2 emissions.
[17] This proposal from Brander and Bjørn (2023) does not use a marginal EF, but instead allows companies to exclusively claim a site-specific EF from an activity pool if a company can show they did something to “cause” the release of emissions to be avoided from that specific site. Effectively, this approach would require application of similar baseline scenario and additionality determination processes to market-based EF claims.
[18] Specified in the current GHG Protocol Scope 2 guidance (Mary Sotos, 2015), but infrequently applied.
[19] Additionality can applied as a binary eligibility or probabilistic (weighted) determination (e.g., Huestis et al. (2022); Gillenwater (2012b, 2008b)).
[20] Although option 2c still allocates emissions (i.e., does not insert avoided emission estimates or a marginal EF into inventory accounting), the exclusive claim to a site-specific EF is justified through a determination that an intervention has caused emissions to be avoided at that site. This approach, thereby, introduces elements of consequential analysis and causal thinking into GHG inventory accounting (see here for a discussion of why the use of causal justification in GHG inventory accounting is problematic).
[21] This thought experiment intentionally does not address the legitimate questions regarding the sustainability of biomass harvest and resulting net CO2 emissions from the use of biomass energy. If this troubles you, instead imagine a synthetic fuel produced entirely using green hydrogen, renewable energy, and captured CO2.
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Cover image via FreePix.uk: Nick Youngson.
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