Listen: Hand in glove: The importance of carbon accounting in emissions reduction

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Sam Humphreys:

Hello, it's Sam Humphreys here from S&P Global Commodity Insights EnergyCents. And I'm here with Hill Vaden. Hill, how are you doing?

Hill Vaden:

I'm doing all right. It's Friday.

Sam Humphreys:

It is Friday. It's glorious. I'm looking forward to the weekend, for no particular reason other than I get to watch some rugby, which we'll talk about in the podcast. How are you?

Hill Vaden:

Yeah, I'm doing all right. I get to travel to Atlanta this weekend for my child's soccer, football, soccer.

Sam Humphreys:

Football. Excellent. Oh, that sounds fun.

Hill Vaden:

Yes.

Sam Humphreys:

Well, we have just recorded a podcast episode on carbon accounting with Simon Thorne. And it was great. What do you think people should be listing out for on this one?

Hill Vaden:

Carbon accounting is something ... Just carbon emissions, all of it we've talked about often in these EnergyCents episodes. And there's so much going on and so much complexity. And Simon does a really good job of describing what carbon accounting is, what we're measuring, how it's supposed to work, where there's consensus, where there's not consensus, where there's business models developing. And it's a fairly ... I guess, the emerging space that the whole ambition is to help the world decarbonize but there's a lot that needs to come into shape before all of this starts to become a normal part of our lives. And I think Simon does a really good job dumbing it down for me and helping to explain and helping just set up the whole thing of why carbon accounting is so important to the energy conversations these days. How about you?

Sam Humphreys:

You've hit the nail on the head there, that's exactly it. And as someone who didn't know an awful lot about it to start with, it's really informative, and just where this industry is going, industry, market, business is going. Yeah, I hope everyone enjoys it.

Hill Vaden:

All right.

Sam Humphreys:

Hello, and welcome to EnergyCents by S&P Global Commodity Insights, where we talk all things related to the intersection of energy and finance. Today, we're talking to head of climate outlooks and scenarios, Simon Thorne, about carbon accounting. My name is Sam Humphreys, and I'm joined as always by Hill Vaden. Hill, how are you doing?

Hill Vaden:

I am doing well. And I'm curious for the two of you all sitting in the UK, I think England announced the team that it will bring to the Euros next week. And I know that both of you are bigger rugby fans than football fans.

Sam Humphreys:

This is true.

Simon Thorne:

Very true.

Hill Vaden:

But Jack Grealish was left off the roster. Does this surprise you? Does it bother you? Do you care at all, because you only watch rugby?

Simon Thorne:

For me at least, Sam, we'll see where you go on this but for me at least, I saw the headline and wondered if I could care less. Because you're right, rugby is the beginning and the end for me. There you go. I read the first couple of paragraphs and I could recognize it was a big deal, but no resonance at all for me.

Sam Humphreys:

You did better than me because I didn't even read the headline. Sorry, Hill.

Simon Thorne:

There you go, there you go.

Sam Humphreys:

Rugby season is over, so I haven't looked at any sports stuff.

Simon Thorne:

Well, there's still one more match, still one more match in the English rugby season, the big final tomorrow at Twickenham, that'll be a hell of a game of rugby.

Sam Humphreys:

Actually, my nephew's going to that.

Simon Thorne:

There you go.

Sam Humphreys:

He won his school tournament or village tournament, so they got free tickets. I'm really jealous, but there we go.

Simon Thorne:

Yeah, there you go. Lovely.

Sam Humphreys:

Sorry, Hill.

Hill Vaden:

No, that's all right. You all know because you guys don't pay attention apparently, that England is the favorite to win this summer, the Euros in Munich. I don't think this is the first time that England is the favorite to win, but it would be the first time in a long time I think, that perhaps they do. But they've got I think, a great squad even without Grealish and even without McGuire. I'm optimistic.

Sam Humphreys:

Are you talking about men's euros, the men's football and not the women, because the women's team did really well last time.

Hill Vaden:

Yes, they did very well. They won.

Simon Thorne:

They won. And the women's rugby team, the English women's rugby team, we are hosting the women's Rugby World Cup. I say we, not Sam and I.

Sam Humphreys:

Yeah.

Hill Vaden:

Not S&P Global?

Simon Thorne:

Yeah, not SB Global hosting the women's World Cup. And we are, England now, one of the absolute favorites in the women's rugby World Cup coming up next season. That's one to watch for.

Sam Humphreys:

Sure is. Sorry, Hill.

Hill Vaden:

That's all right.

Sam Humphreys:

We caught it back.

Hill Vaden:

Yeah. Now everybody that's listening is excited that we're going to talk about rugby and football, and instead we're talking about carbon accounting, which is somewhere as exciting I suppose.

Simon Thorne:

It's close, it's close.

Sam Humphreys:

Yeah. This is a subject that Hill and I have skirted around over the last few months, and we thought it'd be really good to get you on TO just dive into what it actually is. And let's kick things off as just a basic explanation of carbon accounting because it's new and exciting. You take it away.

Simon Thorne:

Absolutely. Thank you very much and thank you guys for hosting, I do appreciate it. Carbon accounting is an often misunderstood word, or words I suspect. It really is a framework, methods to agreed standards for how we are measuring and how we are thinking about what an organization emits. It's carbon specifically but there are broader metrics around greenhouse gases that work as well. It has its origins strictly in the social responsibility side of the industry, and it hasn't strayed too far from those social responsibility origins but it is now really having its time in the sun. Even a year and a half ago now, I was reminiscing on this from a conversation recently with a colleague who attended SIR week, even a year and a half ago when we were talking about carbon accounting in SIR week, you could have a very engaged conversations around it with a very specific persona in a very specific way about very specific things.

But this spring, it felt a different animal and it felt as though the importance of carbon accounting was catching up to the mainstream consciousness around these things and the language around it, the excitement around it, the opportunities are really coming in. But what it is, yeah, it's an agreed framework for measuring often from a baseline position. Reductions in carbon emissions from specific organizations, making sure we have the framework around how to do that, what it means, and they're all speaking the same language. That's in a nutshell what carbon accounting is.

Hill Vaden:

I've got a lot of questions about carbon accounting, and we're not going to get them all out here. And some of my questions are probably stupid questions I suppose, but how is it supposed to work and how ... There's perhaps a critical term, spreadsheet decarbonization, which doesn't perhaps lead to actual decarbonization. And as I understand carbon accounting and the trading involved in it, I can produce more carbon if then I sell a credit to somebody who's producing less carbon or vice versa, and there's all ... But net carbon potentially keeps going up. How's this system supposed to work?

Simon Thorne:

And by the way, my father used to say when I was growing up, there's no such thing as a stupid question. Let's test that theory today here. Maybe we can finally prove him wrong. We'll see, we'll see.

Hill Vaden:

Your father hasn't met me.

Simon Thorne:

He's dead now, so there's no chance either. There you go. The reality is that carbon accounting is down to corporate or unit or specific levels. When you are thinking around carbon accounting, it doesn't try to account for the complication that growth invariably leads to more emissions. On a global scale, there is still as we see, emissions are flat to growing in lots of different sectors. And some of that is around population intensity, economic activity, all that things. When you get down to the individual unit, say a refinery for the sake of the conversation, when you get down to the individual unit, that's where the rubber meets the road. And that's where the correct application of carbon accounting standards should be able to and will be able to, tell you if your activity is actually materially reducing carbon from the baseline that you achieve.

And that way of looking at it has become a really important part of understanding carbon accounting, understanding where the industry is on its decarbonization path because undeniably, the least emitting, however you want to think of it, electron, is one you don't produce. The least emitting oil is one you don't produce. Efficiency goes hand in glove with these reductions, and they're really partners, efficiency and carbon accounting. They're measured on the unit level. They can be very accurate, very specific, and they help you understand what each unit is doing, which is ... And you talk about the trading side, which is very important to understanding trading optionality. And that's also been a big evolution, we are now seeing in trading and it's something we should definitely get to today, we are now seeing people putting emphasis on attracting, keeping it in an oil language for the sake of it, but it applies to anything, people are putting an emphasis on acquiring barrels with a lower carbon intensity, not an outright necessarily, but a lower carbon intensity.

Sam Humphreys:

I just want to clarify one thing because again, we're talking about not stupid questions, we're going to test this to the max. When you say they're being measured at a unit level, what do you mean by that specifically?

Simon Thorne:

If we took a refinery, a refinery is made up of ... And this is true of any industrial process, but it's made up of lots of different units. There's an FCC, there's the CDUs, there's VDUs, any number of bits of equipment. And those bits of equipment are working independently of each other, often in related co mingled processes, but carbon accounting looks to understand the emissions from a site but also from a unit. We can start to differentiate the output profile of carbon from which unit it would be in that process, the activity of what we're trying to do, if we're trying to produce oil for instance, where that works, and that's how we can start to understand specific impacts of reductions as well. And we'll stick to the oil refinery example, within an oil refinery, pieces of that chain to produce jet fuel, different parts of that production do different things and have different carbon outputs. That's what I mean by unit, is that we can understand it on a by unit level, regasification, whatever the unit is but also in a geographic level, what that whole complex is producing. That's what helps us understand and make ... Well, not us, but helps operators make better decisions around what it is and how they can curtail or limit their emissions.

Hill Vaden:

Okay. And so as we're walking through this, what gets measured gets done. And so two questions on this.

Simon Thorne:

100%.

Hill Vaden:

One, is there a global consensus on how to measure it? And then two, is there industrial consensus on who takes responsibility for which bit of carbon? And Sam and I were talking yesterday with one of our analysts who covers autos, and does the auto manufacturer have to take responsibility for the upstream emissions from batteries, or is that the battery maker's problems? Those types of things get into this. Can you help describe this?

Simon Thorne:

Yeah, I can ... Yes. You asked two questions of is there alignment around the way we measure, is there alignment for who takes what part of it? And the answer is no. And this is going to sound small but is big, but there is really for the first time, energy around the idea that there needs to be. If you take the clock back two years and before that, you could be in a room, and I was many times with ... I'll stick with oil for the sake of the conversation. I could be in the room with many different oil majors or refiners, whatever it may be. And originally, they were going their own path and saying, "We have programs to look for verified low carbon ... "

Whatever it might be, jet fuel, et cetera, et cetera. And they would be speaking a different language. And they were not necessarily as convinced that they needed to speak the same language. They felt the goal was demonstrating their own reduction with their own methodology. That's evolved and it's evolving. Now we're in the point where a year and a half ago, people were flirting with the idea of having standards that aligned, which is very necessary for comparison. If we wish to compare oil produced in place A with oil produced in place B, these things aren't created equal in the sense of emissions. In the sense of specification they may be created equal, there are standards that govern those things. But in the sense of emissions, there is no commonality. Now there are oil majors ... And I was speaking to one earlier today, who are all driving the conversation around commonality because they understand now that it's working and it's not just as good as saying, "It's my standard that should prevail."

But that's evolving into, "We need a common standard."

And one of the reasons, I mentioned a few minutes ago, we need to come back to the topic of what this means from a trading standard, but all of those opportunities work when something is comparable. When we can look at the jet fuel that was produced in the Middle East on a like by like by methodology around what its carbon emitted is so that a potential buyer can understand with confidence what the decision they are making really means in a reduction sense.

Now to the second part of your question, Sam and Hill, it's still an active conversation around who is responsible for which part of the emission. The scopes, I'm sure it's the most common thought about way of expressing that conversation, scope one to scope two, to scope three. Scope three, the final emission, is still a very contentious area, still a very contentious area. And whether you speak to policymakers or you're speaking to industry folks or producers or whatever it might be, there's not universal confidence, or comfort more than confidence, there's not universal comfort that the scopes adequately capture where the emission should be accounted for. And that's an ongoing conversation. It's also a very difficult conversation from an S&P lens because there are obviously ... Within that there's a winner and a loser, where one marks that it advantages and disadvantages other parties. It's a very fraught conversation, frankly, with obvious implications up and down. And it's ongoing in this very moment.

Sam Humphreys:

I want to come back in a second, but you were talking before about commonality in this industry, and are we talking about commonality with like for like industries? We've mentioned oil refineries and jet fuels. Or are we talking commonality across all heavy industry?

Simon Thorne:

That's a great question.

Sam Humphreys:

There are cement works, steelworks, or is it still to be decided?

Simon Thorne:

Well, I'll give you the answer and you can figure out if it's still…but it's working its way through. There's an active movement at the moment driven by the banks. To a degree, a lot of the industries see themselves as special and unique, and in their ways they are, but the banks are looking at this from a financing perspective. They need a level of commonality. They are starting to insist that things are bucketed into ... What do you want to call it? Industrial processes. They look at extractors for instance, a word that I hadn't heard until six months ago, they look at extractors as a common affair. And they want commonality across that. And by extractors, fairly obviously from the name, they mean people who are pulling minerals out of the earth as well as people who are pulling liquids out of the earth in the case of oil, or gas out of the earth.

Those industries, whether that's coal, iron ore, take your pick, they've all got their independent view of what makes them unique and special. And it's all true, but the banks look at that and financing of these things is hugely important to the tone of this podcast, of course. But the banks are driving for a commonality of standard to that level at a higher way of looking at these industries and perhaps the people involved in it on the ground are, but the banks are driving a lot of this because money talks frankly. They are looking to impose their lens across these different industries and say, "Look, at the heart, you are doing similar things and we need commonalities. And we can compare opportunities from a financing perspective."

And that's being listened to and understood by the primary industry in a way that hasn't been before. Is it landed on? No, but it's being taken seriously.

Hill Vaden:

Okay, so we're making progress on I guess, the consensus that this can be done, that it can be measured.

Simon Thorne:

Yeah.

Hill Vaden:

Does it reduce carbon, or as GDP grows globally, do we just measure the increase of carbon? How is this going to reduce the carbon that's coming out of the world?

Simon Thorne:

There's two ways of looking at it, understandably. And the answer is that the carbon accounting in and of itself cannot alone reduce overall carbon on a global regional country basis. And that's where carbon intensity is such an important metric. Carbon intensity is the only metric, at least in my opinion, it's the only metric that can make sense of that. From a planet point of view, we wish to see overall carbon reduced. However, developing oil is growing fast. There's lots of energy intensive things that need to be supported, and they have the right to do that. Carbon intensity is the metric by which we can understand the impact of individual units, of individual emitters. If we can have that on the right trajectory of reduction, and there are market mechanisms that can encourage that, I think that's what we can realistically achieve. Does that in any way speak to the issue that as the world's economic activity increases, populations increase, whatever it may be? No, it doesn't. It doesn't guarantee that, but it will ... But it's a controllable metric in the hands of people who can make choices on their unit, their production. But it doesn't speak to the global consequence of production in general though.

Sam Humphreys:

As of now, is carbon accounting required across all businesses, all industries? Because my understanding is investment is ... Companies have a lot of targets for reducing emissions. How necessary right now is it, if this is all in its early stages for companies to be doing this, what's the incentive for them to do this? Is it just that they'd get some money from a bank or ...

Simon Thorne:

There's lots of incentives I think, in this whole scheme of things. Universally, no, there's regional difference, there's different policy differences. There's not one answer to that, and that's one of the problems. Regulatory bifurcation doesn't make these things straightforward. The regulatory requirement of a refinery in West Africa is different than that of a refinery in central US. No, there isn't a single standard. The incentives are there. And one of the key conceits of mating all of this work is that lower carbon intensity goods, services, energy, will at some point, and we're not necessarily there but we might be on a tipping point, will either require a premium or as likely, will be the fungible good, so that if you are talking about a cargo of crude oil in the North Sea, the conceit goes that a buyer will target the lower carbon one because they are less exposed to their customer's willingness to buy, but also from a regulatory exposure point of view.

And now we're starting to see, and it is the start, we're starting to see CBAM, the European regulation that will require people to be exposed to European regulation wherever they are in the world, they've gone on an import basis. That's making a difference. The other reality of all these things is when you look at carbon intense fuels and you stack them all up, if indeed the demand is moving towards lower carbon intense goods, those that sit on the other end of that spectrum and the producers that are wearing more carbon exposure than those that are wearing less, their product becomes increasingly discounted from the top end of things. It's a dual spectrum if you will, where there is the belief that demand will continue to grow for the lower carbon goods, but equally at the other end of the spectrum, that the discount is becoming more profound for the lower carbon part of this.

And that holds up logically, it holds up logically but it's worth mentioning that outside of domestic power consumption here in the UK and many parts of the US, many parts of the world, Europe certainly abundantly, you can choose a power provider for whom often you will pay a premium for a lower carbon intensity good. But that's about the only place that exists. That doesn't happen if you wanted to buy a toothbrush today, that doesn't happen. But there are many people who see that as the end game, and that all goods will become measured and marked on their carbon intensity. Whether that leads to carbon rationing, all sorts of other things as well, that's a very well accepted pathway that some people believe will be the future.

Hill Vaden:

You can do that in Texas, you choose to buy your own power plan and you can choose to buy green power only or whatever power, and it's whatever the number is, three or four cents more expensive per kilowatt hour to buy the green.

Simon Thorne:

And there is a whole host of people who will tell you that that ... And the same here in the UK, same in France, same in X, Y, Z country. And in fact, I do funnily enough, well, we do in my family. Sounds like you do too, Sam, but ...

Sam Humphreys:

We do, yeah.

Simon Thorne:

There you go. Not that we're the exceptions in the power industry, because I don't know if that's true or not, but it's the one industry where there is ... Or one of the very few industries where there is a proven customer demand for a lower carbon product. There were all sorts of flirtations with this just before the pandemic, '18, '19 area, where there were various attempts on a professional traded market, LNG, crude oil, to prove a differentiated cost for lower carbon. And there was a flurry of activity, I think it was '18, can't specifically remember, '18 or '19, and there was a whole flurry of activity pushing in that direction. Most of it's faded away. There was a spike, it's fallen away. I'm not prepared to say personally that that endeavor is over. It does feel as though it marched in that direction because you certainly see it in buying patterns where people are targeting the lower carbon commodity. Are they paying a premium? Not necessarily, not today, but it is implying a discount for the higher carbon goods. And that tantamount gets you to the same area.

Hill Vaden:

Think about this with economics classes that we took in college or whatever, commodities are imperfect competition, that if I buy oil or oranges or whatever, there's little differentiation. And that's a hard place to be compared to iPhones or sneakers or something that has a premium component to it. I guess, it sounds like this is a way for commodity producers to add differentiation to their business. It sounds like there's also a way to add asset light business to what is an asset heavy. And if you look at the stock market today, the asset light businesses are getting higher valuations in the asset heavy businesses. Can you give some examples of what's happening in this space from the business side of things and from the investment side of things? It sounds like regulatory is slow and there's an awareness and there's stuff happening, but can you talk a little bit more about ...

Simon Thorne:

But moving, but moving.

Hill Vaden:

But moving. About the business.

Simon Thorne:

Yeah, absolutely. Absolutely. And a lot of it is circumstantial. If you're looking at the North Sea as a significant producing basin of oil, the carbon intensity of assets producing oil in that area vary wildly. We've done some research around that from the S&P Center of Emissions Excellence. It's powerful and it's a great way to have the conversation with industry because you have a molecularly similar product to your point, Hill, that is very interchangeable on an economic basis. There are some performance differences around API et cetera, in the refinery, but generally speaking there's high levels of interoperability. But the carbon intensity varies wildly, varies wildly. When you look at the graph, it's staggering how much that can differ. And a lot of that is situational. A lot of that is geographically situational on the extraction method that you are using, and hard to invest your way around.

And a refinery similarly, you'll find a lot of European refineries are on the older end of the spectrum, as you both know. Technology has improved over time. And typically more modern refineries, perhaps on the Indian ones or some of the Middle East ones have a lower carbon intensity inherently. And there is an inherent component to carbon intensity, at least without very heavy investment in what the alternatives will be. That's where the efficiency piece I was talking about comes in as well. A lot of the drive in the industry right now is maximizing efficiency to lower carbon intensity scores, but also in the idea that particularly in the western world, the idea that the unproduced is the most relevant, it's the most carbon efficient, the most least energy intensive, it's the best molecule that you can provide. What will come, I suspect, Hill, and we're starting to see it now, is that as people do the maths and as the regulation starts to change, it incentivizes more investment in reduction than we are currently seeing. And that's an evolving space, it's not done and dusted. But that level of investment and the outcome of that regulation, speaking to that quite heavily ... And it's still at the beginning regulation and it's still working its way through, but that will evolve over the next months and years as well.

Sam Humphreys:

There's a really nice graph on the emission intensity on social media in the North Sea. For people that are listening, they might want to check that out, but illustrates that point brutally.

Simon Thorne:

And assumingly, we're talking about the same graph here. I'm not sure, Sam, but I think we're talking about the same one.

Sam Humphreys:

Yeah, I think we are.

Simon Thorne:

That stuns people who have worked in the industry for 30, 40 years and know the production portfolios inside now and almost to the point that I've sat in the room with ... In the Netherlands funny enough, I sat in the room quite recently with a senior refiner who was incredulous that the range could be that wide. We went through the whole thing and he got there in the end, but that graph blows people's minds, people who've been in this industry their whole lives, grown up around it, which tells you how little this is thought about in the way that we're now talking about or has historically been as well, by which I'm not suggesting any lack of sophistication, it's just not the way that it's typically been understood.

Sam Humphreys:

We are watching the time now. Before we wrap up, we wanted to get your thoughts on some near term things that we should be watching out for in this space, whether it's regulations or policy or anything.

Hill Vaden:

Or even S&P plans. You can talk about some of the things that our employer's doing in this space if there's something there to flag.

Simon Thorne:

Yeah, there's a couple of things. Regulation is going to be key, Sam, and the pace of regulation, CBAM doesn't today have a liquids component to it, but it will, I'm pretty fairly sure it will. The regulatory framework that's changing all the time, and regulations in the US, there are so many powerful economies looking at this topic and they want to have their regulatory stamp on it. That would be the place I would say we need to look at constantly.

In S&P, we are focusing very heavily on carbon intensity numbers, carbon intensity production. And our colleagues in the center of emissions excellence are all over this topic. We are convinced that this will be a vital metric to facilitate this industry. We've also got a partnership, Agora with Palantir, which is proving a very important venue to express those metrics in a way that makes them usable. And that's from a trading perspective or any other, but it's really giving us the ability now to compare carbon intensities in a very visual, very appealing way that's empowering decision. They're the two places I would look. Have a look at the Agora stuff that you can find. If you two both don't know, I can send you the link on the website to where you can find those things.

Sam Humphreys:

Pleased do.

Simon Thorne:

But it's easy to find our website. And then the regulation space, we're spending a lot of time tracking that regulation, going to be vital in how this industry is coming together.

Hill Vaden:

All right. I'm going to define a couple things that you introduced. CBAM is Carbon Border Adjustment Mechanism, it's an abbreviation in the Center of Emission Excellence. The abbreviation for that is COFEE, and I don't know the carbon intensity of coffee, but I thought it was very clever.

Simon Thorne:

I hope it's low, I'm addicted to it myself.

Hill Vaden:

There's probably other things with higher carbon intensities that we're all three addicted to as well. Coffee may be the least of our problems.

Sam Humphreys:

Fantastic. Awesome. Any other comments, Hill, before we wrap up?

Hill Vaden:

No. Good luck to England next Sunday playing Serbia in the opening round of the Euros. And good luck to the rugby match that you guys were talking about earlier. I don't know anything about rugby.

Simon Thorne:

Maybe this is the weekend to learn, Hill. Bath Rugby take on North Hampton Saints, be a heck of a match.

Sam Humphreys:

It's going to be a good one. Just a reminder to our listeners, if you like what you've heard, please like and subscribe to the podcast. And if you have any questions, you can reach out to spglobal.com/commodityinsights. Simon, thank you so much for joining us today. It's been a great conversation. And yeah, I hope everyone enjoys it.