Understanding Scope 1, 2, & 3 Emissions: How you can Reduce Your Emissions With Tax Credits

BY BRYEN ALPERIN, DIRECTOR OF RENEWABLE ENERGY AND SUSTAINABLE TECHNOLOGIES

A March 21 meeting of the Securities and Exchange Commission (SEC) proposed a reporting framework for publicly traded companies to provide information about the carbon intensity of their businesses. Voluntary disclosure of climate risk factors has already become widespread in recent years, with the SEC estimating that about one third of regulatory filings submitted by public companies in 2019 and 2020 included some degree of environmental impact assessment. Standardizing these disclosures will make them more functional for investors as “consistent, comparable, and reliable information” on climate-related risk exposure, says the SEC’s recent guidance.

Carbon accounting, the process by which emissions are calculated and attributed, has evolved in recent years thanks to work by the World Resources Institute and the World Business Council for Sustainable Development. Their joint Greenhouse Gas Protocol lays out three principal areas of emissions:

Scope 1: Direct Emissions

Scope 1 emissions result directly from business activities, such as fuel used in vehicles owned by the company and exhaust from running manufacturing equipment. This is the simplest scope of emissions to calculate and would be required of all publicly traded companies under the proposed rule change. One option for reducing your Scope 1 emissions are carbon offsets. Example carbon offsets you can purchase include forest preservation, energy efficiency projects, or carbon capture. There are a variety of brokers which sell carbon offsets, but since the market is largely unregulated, it’s important you work with an expert advisor to perform due diligence on your purchase.

Tax Credit Use Case:

The recently improved 45Q Sequestration Tax Credit is a tax credit for carbon capture and sequestration. Projects which generate 45Q tax credits may also produce carbon offsets, and tax credit investors may be able to gain access to carbon offsets which would reduce their Scope 1 emissions.

Scope 2: Indirect Emissions

Scope 2 emissions describe the indirect burning of fossil fuels on a company’s behalf by its power providers, usually local utilities. This aspect of the corporate carbon footprint can be offset in three ways: 1) a business may choose to directly supply its own clean energy, i.e., by installing solar panels on its offices and facilities; 2) , a company enter into a “bundled” power purchase agreement (PPA) with a clean power generator such as a solar plant or wind far; or 3) a company may purchase “unbundled” renewable energy certificates. Scope 2 emissions reporting would be required of all publicly traded companies under the proposed rule change.

Tax Credit Use Case:

The development of renewable energy power plants such as solar and wind are dependent on third party investments from tax credit investors. These transactions can be structured so that the tax credit investor also gains access to renewable energy certificates generated which would reduce Scope 2 emissions.

Scope 3: Indirect Downstream and Upstream Emissions

Scope 3 emissions account for the indirect climate impact of a company’s suppliers and customers. On the upstream side, Scope 3 considers the sourcing of raw materials and the carbon intensity of vendors’ business practices. On the downstream side, Scope 3 accounting assesses the impact of consuming a business’s products and packaging. Scope 3 emissions are the most outside of a company’s control and the most difficult to verify, leading the SEC to specify an initial “safe harbor” phase-in period to shield reporting parties from litigation as the accounting standard matures.

Tax Credit Use Case:

Several corporations have made headlines for their efforts to reduce Scope 3 emissions by pushing their suppliers to commit to using 100 percent renewable energy. A tax credit investor could help reduce Scope 3 emissions by investing in projects which supply clean energy to their own suppliers.

Conclusion

In commentary from the March 21 meeting, the SEC notes that its duty is to provide investors with material information on public companies. Public stakeholders have increasingly demanded reporting on the climate-related risks of their investments as the materiality of these risks has come into focus. The proposed new standards would give stakeholders more insight into corporate carbon footprints, prompting corrective action.

Businesses may meet these potential new reporting requirements by continuing to invest in productive assets that generate clean energy, sequester carbon dioxide, and promote innovative, low carbon alternative production methods. Tax credit investments in renewable energy may present strategic opportunities to reduce emissions while generating a positive investment return.

Foss & Company works with corporate and industrial partners to fund projects that produce clean energy and sequester carbon dioxide. Our projects qualify for state and federal tax credits and may generate cash flow.

To find out more about Foss & Company’s ESG investment methodology, get in touch with our team today.