This blog is the first in a three-part series on sustainable finance metrics that better evaluate corporate climate risk, opportunity, and impact, and make metrics more relevant to financial decision-making.
Corporate climate practices have matured for over a decade, creating a specialized industry of experts evaluating climate performance within and outside of firms of all stripes. Greenhouse gas (GHG) footprinting has been the industry’s main yardstick to date. However, since footprinting is generally backward-looking, corporate sustainability practice has also begun to emphasize a more forward-looking perspective, focusing on transition plans. Transition planning has often continued to lean heavily on footprinting by focusing on footprinting targets. Recent efforts, like the World Benchmarking Alliance-hosted ACT Framework, developing a sophisticated array of transition plan variables. The International Sustainability Standards Board has also recently published guidance on transition plan disclosures, with a similarly all-encompassing approach capturing a wide arrange of process, interim, and outcome metrics.
Despite efforts to make these climate practices more relevant to business, concepts like GHG footprints, 1.5°C targets, and transition plans often remain abstract for corporate officers and banking and investment analysts. Sustainable finance remains niche. More sophisticated frameworks add complexity, risking that they become even less accessible.
This blog makes the case that transition planning is an opportunity to renew focus on a simpler set of variables. I argue that a company’s capital asset mix is the centerpiece of its current climate performance, and its capital plan – and particularly its CapEx – is the key to understanding a company’s climate future.
Stepping out of the footprint
The appeal of footprinting is clear: our collective climate fate depends on how much GHG emissions make their way into the atmosphere, and every ton matters. GHG Footprints are ascertained by calculating – or more often, roughly approximating – all of the GHG emissions with which a company can be associated. By incorporating all the emissions a company touches or facilitates within the footprint, no matter the relationship, footprinting aims to incentivize the company to pursue emissions reductions wherever it might have influence.
From most businesses and their investors’ perspective, though, the footprint can seem like an abstract concept divorced from the company’s core purpose–making and selling a product for a profit. It can also be hard to translate clearly into financial risk and opportunity. It becomes all the harder when the footprint aggregates widely varying risks and opportunities: footprints combine emissions from all over the value chain, each representing a different relationship to the company’s business and subject to different competitive, regulatory, legal, and social pressures.
An emissions footprint might help an analyst consider exposure to a hypothetical global carbon price, where every exposure represents a hidden cost, but analyzing any more realistic policy context requires a whole new skill set to connect back to financial value. As much as it has become the bread-and-butter of the corporate sustainability industry built around it, the relevance of footprinting rises and falls with that industry, and struggles to break through as part of conventional financial analysis.
The very real world of capital planning
Another way of thinking about a company’s relationship to emissions is through its capital assets. Capital assets are durable, long-lived objects – anything from factories and machines to dairy cows and standing timber – that produce something that generates the company revenue. Capital assets are also implicated in the vast majority of corporate greenhouse gas emissions. Capital assets: emit GHGs directly (so-called Scope 1 emissions), demand emitting inputs (Scope 2 and upstream Scope 3), and create emitting products, like fossil fuels or the various machines that use them (downstream Scope 3). While there are exceptions, like company emissions due directly to land use change, capital assets largely define a company’s emissions profile, especially for the most climate-relevant companies.
If a company’s capital assets largely “lock in” present-day emissions, its capital plan is a choice that foretells the company’s climate future. Understand a company’s plan for acquiring, developing, and maintaining its capital assets, and you have a clear picture of its future emissions. Is the company planning to build plants for electric or gas-powered cars? Green steel mills or coal-burning ones?
While capital plans aren’t a standard metric, CapEx—the investment in new capital assets—is at their core. CapEx shows where a company is headed, what emissions it’s enabling, and whether it’s supporting or delaying the transition with its balance sheet.
Making CapEx central to evaluating corporate climate performance has several benefits. First, it provides a clear and essential link between climate performance and financial value. A company’s future revenue is intimately intertwined with its CapEx, particularly for the most emissions-relevant ones. Because new capital assets are expensive, companies must evaluate their viability and plan for them. This makes CapEx and capital planning a key preoccupation of financial analysis already: companies and investment analysts already scrutinize whether planned investments will generate the revenue necessary to justify them. Overlaying an evaluation of climate-related risks and opportunities should be a natural extension of financial diligence, folding in questions like: Do planned CapEx (or lack thereof) make financial sense in a carbon-constrained world? Does the expected revenue from planned assets reflect competition with emerging low-carbon technologies (and, if the company miscalculates, how would early retirement affect liabilities, dividends, creditworthiness, etc)? From the investor’s perspective, is the company’s valuation built on proper assumptions about these assets and their value based on the revenues they are projected to generate?
Centering capital plans also helps ensure transition planning does not overly rely on GHG target-setting. Focusing on capital plans helps to avoid the loopholes that come with distant 2050 targets that are easily gamed and the struggles associated with getting companiess to secure short-term 2030 targets. In 2023, only 6% of Fortune 500 companies had climate targets for 2030 or sooner, compared to the 33% with longer-term targets. Short-term GHG pledges may become less important for understanding a company’s future footprint anyway: a company’s CapEx can inform a realistic calculation of its emissions over the next decade or more, and certainly five years. It can also capture companies with low footprints, but that are dependent on high-carbon industry supply chains (think oil and gas services).
Focusing on the company’s CapEx also helps us escape what I will call the “good emissions paradox.” At the heart of decarbonization is replacing carbon-intensive goods with zero-carbon goods and services, so-called “climate solutions (I and others deep-dive on climate solutions investing in this 2024 for the Global Impact Investment Network). Companies scaling hard tech climate solutions are essential, and we should encourage investors and lenders to enable them to scale. The problem arises when hard tech companies with new solutions inevitably increase emissions in those business lines as they go from a asset-light businesses of idea and office space to the asset–heavy material reality of factories and plants. Overly focusing on the footprint treats these emissions, essential to creating a net-zero economy, as a harm, and pushes financing toward capital-light businesses that may play little role in creating a net-zero economy. CapEx gives us an alternative metric through which to evaluate the company, complementing the footprint, and enabling us to ask if capital-intensive companies are building climate solutions or locking society into future emissions. In a sense, although CapEx foretells a company’s emissions profile, it is not merely a proxy for emissions but an indicator of the company’s role in creating or delaying the net-zero material economy.
Applying CapEx in practice
The link between capital planning and emissions is not new. Initiatives like the Taskforce on Climate-related Financial Disclosures and the Science-Based Target Initiative make some reference to capital planning as important metrics, but do not focus on it. Capital planning does, however, underpin a few approaches to corporate accountability today. Carbon Tracker Initiative’s famous oil and gas supply cost curves evaluate whether the capital plans of energy companies exceed the carbon budget implicit in climate scenarios, assuming any remaining budget is eaten up by the least-cost reserves. The Paris Aligned Capital Transition Assessment (PACTA), created by 2dii and acquired by RMI, effectively evaluates the “alignment” of capital plans of each company in the financial portfolio to climate scenarios, assuming carbon budgets are divided regionally and sectorally on a fair share basis.
The Accelerate Climate Transition (ACT) Initiative has also recently emphasized the importance of CapEx, elevating it in its framework. The framework’s CapEx-specific metric, however, only tracks a company’s CapEx in “green” technologies, ostensibly to see how serious they are about investing in the transition, while lumping all other CapEx together. This approach is too narrow. It misses CapEx’s ability to answer the most climate-salient question we can ask a company: Are they building durable assets that lock the economy into a high-emission future, or not? It is great to track green capex, but we should also want to know whether a company is investing in the ability to produce internal combustion engines, locking in fossil fuel demand with its product versus, say, ball bearings that can be used for anything from cars to wind turbines. While ACT’s Framework does implicitly track high-carbon CapEx choices with other metrics – benchmarking companies against sector pathways, and evaluating lock-in, for example – it requires greater expertise from users to piece together the story across multiple variables at the cost of simplicity.
The limits and future of CapEx as a climate metric
One challenge of focusing on CapEx is that it is not equally relevant to all companies, whereas everyone can prepare a GHG footprint. There is a sort of cultural solidarity to the latter: companies with vastly different business models and operations can be enlisted in the transition to a net-zero economy by encouraging them to assess and manage their GHG footprints. On the other hand, not all companies are equally climate-relevant, and narrowing attention to capital-intensive companies and sectors may bring focus on the companies most relevant to the net-zero transition, whether managing for risk or impact.
Another challenge is that companies often disclose relatively limited, high-level information about their capital plans in their financial disclosures. That does not mean the information is unavailable: third-party service providers abound. Carbon Tracker, for example, has long used Rystad Energy’s data sets and PACTA’s multi-sector analysis aggregates licensed data from multiple providers. Again, this loses some of the “we’re all in this together” approach to centering the discussion on a company’s publicly disclosed GHG footprints and targets to which everyone has equal access, but also it may shift attention away from a company’s stated aspirations and toward a more productive conversation about where the business is investing and what it means for its future and for climate.
Companies will also often claim that capital planning details constitute commercially sensitive information. Even if true, sustainability and conventional financial professionals engaging with company transition planning will need a more granular understanding of capital plans, and the company’s assumptions about the revenue its durable capital assets will generate in an increasingly volatile, decarbonizing world. This tension points to an alternative priority for investor-company engagement versus, say, continued wrangling over the adequacy of Scope 3 disclosures. Focusing on capital plans may also finally help bridge the gap between sustainability and conventional finance.
There are, of course, also complexities in identifying what constitutes “good” and “bad” CapEx, from the perspective of risk, opportunity, or impact. In one sense it is simple, since decarbonization is fundamentally about replacing emitting capital assets (and fixed capital stocks more generally) with non-emitting alternatives, but edge cases can be complicated. (I explore this issue more deeply in a paper on climate solutions.)
CapEx revives emissions accounting measurement
In financial analysis, as in sustainability, no metric provides a complete picture of a company’s state or future. It is therefore always important to develop a range of metrics and understand their strengths and limitations. This principle, however, does not tell us where to focus. I argue that CapEx is where to focus: a metric that clearly connects climate risk, opportunity, and even impact, to financial value creation in a way readily understood by the financial world, and that tells us whether a company is creating a material world that locks in emissions, or one that substitutes it with climate solutions. This means treating the company’s capital plan as the heart of its transition plan, complemented with other useful metrics.
The good news is that capital investment in clean energy is taking off in the aggregate: the IEA estimated about $2 trillion of capital investment in 2024 in the low-carbon energy system, and twice that of capital investment in the fossil energy system (the merits and demerits of tracking these as ratios will be explored in the next blog in the series). By 2030, though, the same IEA analysis shows that capital investment will need to grow three times faster — while high carbon capital investment must continue to decline — to be on target to decarbonize by mid-century while also meeting society’s growing energy demands. If “what gets measured matters,” surely CapEx is a metric that matters a great deal on the road to a net-zero economy.
Ilmi Granoff
Ilmi Granoff is currently a partner at the strategic advisory firm Climate Technology Group and a senior fellow at the Sabin Center for Climate Change Law. He is also a member of the Climate-related Financial Risk Advisory Committee (CFRAC) of the Financial Stability Oversight Council at the US Department of the Treasury, and a visiting senior fellow at the Grantham Research Institute at the London School of Economics. Ilmi is a non-executive director of Carbon Tracker Initiative, Inc. and a member of the Advisory Board of InfluenceMap.
Great Job Ilmi Granoff & the Team @ Climate Law Blog Source link for sharing this story.
