Location-based and market-based: Understanding Scope 2
Since its publication in 2001, the GHG Protocol’s distinction between three types of GHG emissions according to their source has become widely accepted. Referred to as “Scopes”, these categories distinguish between direct emissions, indirect emissions and value-chain emissions, and its the second of these we will explore in this insight. So-called Scope 2 includes indirect emissions that result from all purchased, acquired and consumed electricity, heat, steam, or cooling for a company’s own use. However, somewhat confusingly, companies often disclose two figures for their Scope 2 emissions, a “location-based” one and a “market-based” one. But what’s the difference? The answer lies in understanding that both location-based and market-based are two distinct methods of calculating Scope 2 emissions. Therefore, they should not be added together to form a total Scope 2, as this would be double counting emissions. Let’s take a closer look.
Location-based Scope 2
The GHG Protocol defines location-based Scope 2 emissions as a calculation method that tracks energy production information to actual energy delivery. So, a company’s emissions are tracked based on the average emission factors associated with the geographic location of its operations. In other words, this method provides companies with an estimate of their emissions based on the average emission factors of the electricity sources in their region without considering specific suppliers. Let’s take an example.
Company A needs to report its Scope 2 location-based emissions. Here are the steps it should follow:
Data collection: gather data from the past financial year relating to their purchased/acquired and consumed electricity, heat, steam, or cooling for their own use.
Identifying the grid's energy sources: determine the energy mix of the grid that supplies electricity to the place where its operations are. This information is usually available from regional energy authorities. Let's say the energy mix is composed of 40% coal, 30% natural gas, 20% renewable energy sources, and 10% nuclear.
Calculating emission factors: Company A will need emission factors for each energy source to calculate the carbon emissions associated with their electricity, heat, steam or cooling consumption. Emission factors are measurements of how much CO2 is emitted per unit of energy generated. For this example, let's use hypothetical emission factors: coal (0.9 kg CO2/kWh), natural gas (0.5 kg CO2/kWh), renewable energy (0 kg CO2/kWh), and nuclear (0 kg CO2/kWh).
Calculating emissions: now, Company A can calculate their Scope 2 location-based emissions using all 3 steps:
Emissions from coal-based electricity: 1,000,000 kWh * 0.9 kg CO2/kWh * 0.4 (40%) = 360,000 kg CO2
Emissions from natural gas-based electricity: 1,000,000 kWh * 0.5 kg CO2/kWh * 0.3 (30%) = 150,000 kg CO2
Emissions from renewable energy-based electricity: 1,000,000 kWh * 0 kg CO2/kWh * 0.2 (20%) = 0 kg CO2
Emissions from nuclear-based electricity: 1,000,000 kWh * 0 kg CO2/kWh * 0.1 (10%) = 0 kg CO2
Total Scope 2 location-based emissions = 360,000 kg CO2 + 150,000 kg CO2 + 0 kg CO2 + 0 kg CO2 = 510,000 kg CO2
Market-based Scope 2
The GHG Protocol states that for market-based Scope 2 emissions, energy production information is separate from actual energy delivery. At first glance, this may seem somewhat illogical. How can you separate energy production from the energy delivery itself? The answer lies with the presence of contractual instruments, including direct contracts, certificates, or supplier-specific information. These instruments go from the energy generation facilities to the energy supplier and finally to the energy consumer, supporting consumer claims about the type of energy used and its related attributes, including the GHG emissions produced at the point of generation. They can also be fossil fuel contracts - they don‘t always have to relate to renewable energy. Let’s take an example.
Company A reports the following figures for its Scope 2 emissions:
Scope 2 (market-based): 243,863 mtCO2eq
Scope 2 (location-based): 754,211 mtCO2eq
The market-based figure is significantly lower because the company has purchased energy from a particular energy facility which provides it with a renewable energy certificate stating the GHG emissions produced at the point of generation. In reality, logistically the energy used by the company will have been the energy available through the local energy supplier, which has been generated at a different energy facility and for which the GHG emissions produced at the point of generation were different. However, for the purposes of the market-based method, this does not matter - as the energy generation is separate from the actual energy delivered.
It is worth noting that the method the company uses will depend on the country and energy market in which they find themselves. If such contractual instruments are available in any market where a company has operations, this requires them to report according to the market-based method as well as the location-based method, although many only report the former.
Navigating contractual instruments
Types of instrument
Contractual instruments come in various different forms, including the following:
Power Purchase Agreement (PPA): A PPA is a contract between an electricity consumer and a renewable energy supplier. In this agreement, the consumer commits to purchasing a certain amount of renewable energy from the supplier. This can help the consumer reduce their Scope 2 emissions by directly sourcing clean energy. PPAs can be structured in various ways, such as virtual PPAs (financially settled) or physical PPAs (delivery of actual energy).
Renewable Energy Certificates (RECs): RECs are tradable certificates that represent the environmental attributes of renewable energy generation. An organization can purchase RECs from renewable energy projects and although not a direct contract, their purchase can still be seen as a contractual commitment to support renewable energy production.
Supplier Agreements: Large organizations might work with their suppliers to encourage them to adopt sustainable practices, including reducing their emissions. Supplier agreements can include provisions related to environmental standards and expectations for emissions reductions.
Collaborative Initiatives: Organizations can join industry-specific or cross-industry initiatives aimed at reducing emissions collectively. These initiatives often involve multiple stakeholders and can include contractual agreements or memorandum of understandings (MOUs) outlining the shared goals and strategies.
Energy Efficiency Contracts: Organizations might work with energy service companies (ESCOs) to improve energy efficiency in their operations. These contracts can include clauses related to emissions reduction targets and energy-saving initiatives.
Sustainability Agreements: Some organizations might enter into broader sustainability agreements that encompass various environmental goals, including emissions reduction. These agreements can involve partnerships with governmental agencies, non-governmental organizations (NGOs), and other stakeholders.
Key content
A contractual instrument of the kind used to calculate Scope 2 market-based emissions should clearly identify the following 5 elements:
Energy resource type
Facility location
Facility age
Certification or label name (if applicable), such as EKOenergy
State whether it contributes incremental funding to new projects. In some markets, only renewable energy facilities can produce such certificates, whilst in others, all energy facilities can.
Why does it matter?
Location-based emissions are around 75% larger than market-based emissions
In a study carried out by Carbonary of data from over 1900 public companies, Scope 2 emissions were, on average, 75% higher when calculated with the location-based method compared to the market-based one. The most significant gap can be seen for Utilities, Consumer Discretionary Distribution & Retail, Materials, and Health Care Equipment & Services, each with over 100% difference. This indicates that these industries are actively paying for contracts to purchase energy from less pollutant sources and offset their Scope 2, even if this is not necessarily the energy that is actually delivered to them.
Scope 2 is a small percentage of total emissions
Zooming out to look at the bigger picture, Scope 2 usually only accounts for around 4.2% of a company’s total emissions, the vast majority originating from their value chain. The industries for which this percentage was above average were Media & Entertainment (14.6%), Telecommunication Services (13.6%), and Software & Services (12.5%). Those for which this percentage was below average were Capital goods (0.13%), Energy (0.74%) and Real Estate Management & Development (0.8%). Despite Scope 2 emissions being significantly lower than Scope 3 emissions, arguably, they are more straightforward for a company to reduce, if they have the financial means. The sheer scale of Scope 3 and the fact that it involves coordinating with many internal and external stakeholders makes reducing it more challenging.
Overall, if the market-based method is relevant to a company, they should provide the figure when disclosing their emissions - but not at the expense of disclosing their location-based figure. It is the latter that is linked to actual energy delivery and that is taken into account in Carbonary’s calculations to determine a company’s total emissions before any form of compensation can be considered (e.g. whether they have contractual instruments for Scope 2 or have purchased carbon credits). Providing both location-based and market-based figures for Scope 2 ensures the highest level of transparency and provides more clarity on where the company’s efforts to reduce residual emissions are concentrated.
