This is an ongoing conversation between José Ortiz, ExcelSense's Chief Research Officer, and Carlos Infantes, ExcelSense's founder and CEO, on the subject of carbon emissions and how the effort to achieve net zero targets will impact real estate asset managers and investors. It will be updated on a weekly basis, as we advance in our goal of creating a modeling tool to measure emissions inferring data from our financial modeling tool.
Understanding Net Zero methodology and the role of Scopes play when managing a CRE portfolio
Hello José, Welcome to the second round of the series. Today I would like to get a grasp on the methodology we will have to adopt over the next few years. Last week you mentioned that there are 3 scopes to be taken into account.
Let's start there, if you don't mind: Explain to us in a non-technical way the concept of scopes and how are they relevant?
Hello Carlos, yes, great to be here for a second round...
There are three ‘Scopes’ or categories of Greenhouse Gas (GHG) emissions widely accepted for reporting purposes. These relate to the level of direct control you have over them:
- SCOPE 1 covers direct emissions from owned or directly controlled sources, namely your company vehicles and facilities.
- You have less control over the emissions from the generation of the electricity, steam, heating and cooling you purchase for your own use… So this becomes your SCOPE 2 reporting.
- And finally, SCOPE 3 includes all other indirect emissions that occur in your company’s value chain. These are lots of different things and it soon becomes very complicated. In the CRE sector this is pretty significant and captures many sources of emissions... From your asset managers commuting to their office to the energy use in your leased assets and franchises, construction works, transport of materials, etc...
There is nice illustration from the UKGBC that shows this pretty clearly:
So, if I interpret this correctly, the emissions under Scope 3 for me would also be accounted for under Scope 2 for my supply chain, and in a similar way, emissions under Scope 2 for me would also be accounted for under Scope 1 for my energy providers. So, aren't we counting multiple times the same emissions?
We are indeed. But there is no double counting. Each Scope or group of Scopes serves its own purpose. You would only add all Scope 1 emissions (assuming everyone was accurately reporting them worldwide) to know how much GHG we are releasing to the atmosphere collectively. but that wouldn’t tell the whole story. If you were to sort every company by their Scope 1 emissions, you would have primary sector industries (utilities, mining, etc) on the very top… But the majority of their emissions are linked to third party use of their product. So we ‘reassign’ part of those emissions through Scope 2 to their clients and through Scope 3 to the end users.
Why is this important?
Because this allows you to take responsibility over your supply chain and choose providers with a lower impact on your Scope 2 or Scope 3 emissions. Thus encouraging them to improve the energy efficiency of their products...
I see, it makes sense. So the idea is that you don't only act on your direct emissions but that you engage with your suppliers and assist them to implement sustainability initiatives. In that sense how do you account for the emissions you introduce or extract from your own system when you purchase or sell an asset, (the embodied emissions)?.
Ok, transferring assets is slightly tricky and due to the current difficulty for the CRE sector to gather accurate data on whole life impacts for existing buildings, no embodied emissions are currently transferred to your Scope 3 when you acquire an existing building. You effectively only add the In-use emissions of the asset to your Scope 3 on an ongoing basis.
This is different for new buildings where you can more accurately model their whole life impact...
For example, if you are a speculative developer/investor and construct a building to put on the market, you are effectively acting as a ‘manufacturer’ of a ‘product’ and have a higher level of control over the future emissions of those assets. You would account emissions associated to the construction process in your Scope 3 as the building is constructed (we call this Upfront carbon). But that’s not all. You must also account for the building’s whole life emissions (note that this is typically 60 years worth of tenants' estimated energy use and emissions associated with the end-of-life treatment of the building). You take those into account as part of your Scope 3 on the year you sell the building (your product) in the market.
The reason for this is that as the developer, you have more control over the building design and potential performance than anyone else in its life cycle and thus, you are encouraged to choose sustainable solutions not only during the construction process but also during its operation.
The first purchaser of the asset has also some control over the design and as such, must also account for the Upfront carbon emissions (those generated during construction) on the year of acquisition and then, the ongoing In-use emissions of tenants, etc, as part of her Scope 3.
There is not such a thing as ‘transferring’ (meaning displacing) embodied emissions as you can see. They are both counted in the Scope 3 of seller and purchaser to encourage in both sides the adoption of most sustainable solutions…
All right, that’s a lot to process. It sounds like there is a gap in the measurement of whole life impact for existing buildings… And they are the great majority of them! Is this not an area where our under-development ExcelSense inference technology could help?
We are working in several streams and currently the focus is on In-use (operational) energy. Embodied emissions are our second priority and will come down the line once the In-use models show an acceptable level of accuracy. We think there are huge synergies between the models and we are learning a lot as the technology develops.
I’m looking forward to that. Let's continue with the embodied emissions in another talk for a later date and dive now into the different scopes. Which scopes are most relevant to real estate?
Well, it’s key that we all address our Scope 1 emissions. If everyone was to eliminate Scope 1 emissions, there would not be Scope 2 and 3 to worry about. So that should be the most relevant one! Then you want your energy providers to be as green as they can (Scope 2).
But having said so, RE can have a disproportionate influence in the overall reduction of emissions by engaging with the supply chain and encouraging more sustainable solutions up and downstream the value chain. Scope 3 soon becomes very relevant as asset managers and investors’ decisions to engage with more sustainable providers can quickly overtake absolute impact on GHG emissions from their Scopes 1.
Interesting. So for a Core portfolio, I guess you want to focus on Scope 2, but for Opportunistic or Value Add portfolios, the key is to manage Scope 3 emissions. How complicated is it to measure Scope 3 emissions at this point and how do you see the industry tackling this problem in the next few years?
It depends on the specific reporting category. Some are relatively straightforward as, for example, employee commuting in the upstream activities but generally this has a low impact for both developers and owners. Far more complicated and relevant are other upstream activities such as the embodied carbon that, as we discussed above, it is quite difficult to accurately measure for existing buildings.
The industry will resort to the emerging technologies, based on data, that are transforming our understanding of the world in virtually every aspect of life. Artificial Intelligence and blockchain technology will play a huge role in measuring Scope 3 emissions in the near future.
Let's close today's discussion with the last questions: How should a manager go about in terms of starting to gather the right information to be ready to answer the expected requirements on Scope 3 reporting?
It’s key to approach Scope 3 emissions with a manageable approach otherwise you can be easily overwhelmed by the complexity of it. The UKGBC suggests a best practice approach to getting started on reporting Scope 3. In summary, keeping a focus on value generation from measuring scope 3 emissions, understanding your data, starting with a very wide but shallow approach to improve your understanding and prioritise action. Then engaging with upstream and downstream providers and customers to encourage implementation of improvement measures… But the key is to put the information into the hands of those making the decisions. This is what we are working hard here at ExcelSense, to do this using the wealth of data CRE already has available through their financial reporting…
Thank you José, great information, as always. Looking forward to more next week.
My pleasure. See you next week.
P.S. There are a few references in the text to UKGBC. We recommend the reading of their Scope 3 report that you can download from this link.