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Low Carbon Transition Rating

Methodology Abstract

February 2023

Introduction

 

Sustainalytics' Low Carbon Transition Rating assesses the degree to which a company’s projected greenhouse gas (GHG) emissions differ from its fair-share budget for GHG emissions.

The primary output of the rating is a temperature, in degrees Celsius, that answers the question: “To what degree would the world be expected to warm if the emissions of all companies differed from each of their budgeted emissions to the same degree as this company?”

In this way, the rating does not place the entire burden of mitigating emissions on the highest emitters, but acknowledges that all companies have a responsibility to limit GHG emissions according to a set path. Furthermore, the assessment goes well beyond the company’s ambitions and targets, by considering the company’s preparedness to deliver business model transformation.


Methodology Description

GHG Emissions Projections

 

The Low Carbon Transition Rating is powered by extensive data and provides multiple signals but at its heart the concept is quite simple. It is a measure of how much a company’s GHG emissions are expected to overshoot or undershoot its fair share budget of emissions. Critical to making this assessment are three GHG emission projections:

1. The GHG Emissions Budget represents the amount of emissions a company can have while being aligned to 1.5 degrees Celsius. This alignment—often referred to as ‘net-zero’ alignment—is based on companies cutting GHG emissions to as close to zero as possible over the next three decades. The GHG Emissions Budget is represented by the green line in exhibit 1 below.

2. The Baseline GHG Emissions Projection represents the emissions the company is expected to have if it takes no actions to manage its emissions. The Baseline GHG Emissions is represented by the orange line in exhibit 1.

3. The Expected GHG Emissions Projection represents the emissions the company is expected to have based on its management. Strong management suggests that expected emissions will be lower than the baseline emissions while weak management suggests that expected emissions will be higher than baseline emissions. The Expected GHG Emissions is represented by the teal line in exhibit 1.

 

Exhibit 1: Low Carbon Transition Rating Emissions Projections 



GHG Emissions Gaps and Percentage Gaps

The projections are interesting in their own right but ultimately need to be compared to each other to truly understand how well the company is expected to perform. The comparison of the quantitative difference between two projections is referred to as a GHG Emissions Gap. The two relevant “gaps” calculated in the product are:

1. Baseline GHG Emissions Gap: The absolute difference between the company’s baseline GHG emissions projection and its GHG emissions budget projection. When this gap is aggregated for multiple years, this is referred to as the Cumulative Baseline GHG Emissions Gap. This gap is represented by the gray shaded area in Exhibit 2.

2. Expected GHG Emissions Gap: The absolute difference between the company’s expected GHG emissions projection and its GHG emissions budget projection. When this gap is aggregated for multiple years, this is referred to as the Cumulative Expected GHG Emissions Gap.


Exhibit 2: Baseline GHG Emissions Gap

 

The two GHG Emissions Gaps can be further understood by considering the size of the gap relative to the budget. This is done by dividing the GHG Emissions Gap (either Baseline or Expected) by the GHG Emissions Budget and the output is referred to as GHG Emissions Gap Percentage. Similar to the gaps, there are two key GHG Emissions Gap Percentages in the rating:

1. Baseline GHG Emissions Gap Percentage: The relative difference between the company’s baseline GHG emissions projection and its GHG emissions budget projection. When this gap percentage is calculated for multiple years, this is referred to as the Cumulative Baseline GHG Emissions Gap Percentage.

2. Expected GHG Emissions Gap Percentage: The relative difference between the company’s expected GHG emissions projection and its GHG emissions budget projection. When this gap percentage is calculated for multiple years, this is referred to as the Cumulative Expected GHG Emissions Gap Percentage.


 

Implied Temperature Rise Calculation 

The GHG Emissions Gap Percentages are further adapted into Implied Temperature Rise Scores to show the alignment of the company with global temperature goals. The percentage is translated into a temperature according to a standard formula derived from the Intergovernmental Panel on Climate Change (IPCC). This formula uses the Transient Climate Response to Cumulative Carbon Emissions Factor* (TCRE), an IPCC derived factor that determines the amount of radiative forcing (warming) as degree Celsius per megaton (Mt) of GHG emissions.

This calculation can be done for both the Baseline GHG Emissions Gap Percentage and the Expected GHG Emissions Gap Percentage. For the Baseline gap, the output is also known as Exposure and for the Expected gap, the output is also known as the Low Carbon Transition Rating.


*The global average surface temperature change that is expected to result per tonne of GHG emissions, according to the Intergovernmental Panel on Climate Change (IPCC). 

 

GHG Emissions Budget

The GHG Emissions Budget is fundamental to the rating, as it specifies the amount of GHG emissions a company is allowed in each year up to 2050, while being aligned to 1.5 degrees Celsius. The GHG Emissions Budget is calculated for each Scope of Emissions based on the United Nations Principles for Responsible Investment (UN PRI) Inevitable Policy Response (IPR) Forecast Policy Scenario.

The emissions budget is unique to each company, since it is determined by the country specific emissions budgets—mapped to the location of the company’s operations. Exhibit 3 demonstrates how we combine emissions across locations with information about the net zero requirements to project the net zero budget emissions for each company.

 

Exhibit 3: Example of defining yearly trajectory of budgeted emissions for each company

LocationCompany-specific starting point of budget (2021)2022 Location-based emissions change* 2022 Budget2023 Location-based emissions change*2023 Budget
Canada27.00-7%25.11-6%23.60
United States70.00-8%64.40-7%59.89
Total97.00 89.51 83.49

* According to IPR Net Zero Pathway.

 

The sample company’s budget, which starts at 97 metric tonnes in 2021, declines to 89.51 metric tonnes in 2022 and to 83.49 metric tonnes in 2023. Although we only show two years in the example, this same exercise is carried out for all years in the projection, typically to the year 2050. Collectively, these annual projections make up the company-specific emissions budget.

 

Baseline GHG Emissions Projection and Exposure

The Baseline GHG Emissions Projection is the second key component for calculating the Low Carbon Transition Rating.

Underlying this assessment is an evaluation of the company’s Baseline GHG Emissions as compared to its GHG Emissions Budget, with the difference between the two known as the Baseline Emissions Gap. These values are calculated for each scope and for each year up to 2050. Then, they are combined to understand the cumulative amount of Baseline GHG Emissions and GHG Emissions Budget.

Baseline GHG Emissions Projection

The current year’s baseline GHG emissions is projected into the future by assuming that the company continues to have the same market share—production increases or decreases at the same rate as the market—and that it has the same carbon intensity for each unit of production as it does now. Expected changes in business activity are based on the International Energy Agency’s (IEA) Stated Policies Scenario.

With projections of emissions calculated into the future, the Cumulative Baseline GHG Emissions Projection can be calculated. This figure adds all baseline emissions from the current year to 2050. The Cumulative Baseline GHG Emissions are then compared with the GHG Emissions Budget, with the difference between them known as the Cumulative Baseline GHG Emissions Gap. The emissions gap can also be considered a measure of how much a company’s GHG emissions are expected to overshoot or undershoot its company-specific emissions budget. Exhibit 4 depicts an example where the company’s baseline GHG emissions overshoot its budget, with the shaded area depicting the GHG Emissions Gap/Exposure.


Exhibit 4: Company Baseline GHG Emissions Projection Versus Company GHG Emissions Budget


 

Exposure

When the company’s Baseline GHG Emissions Gap is translated into an Implied Temperature Rise Score, this is referred to as the company’s Exposure. It assumes that the company simply follows current stated policies and takes no additional management actions that would increase or decrease emissions. The implied temperature rise specifies to what degree the world would warm if all companies’ emissions differed from their net zero budgeted emissions to the same degree as this company.

 

Expected GHG Emissions Projection and Management

Although the Baseline GHG Emissions Projection is useful for setting the stage of the starting point of a company, it does not give the full picture of where the company’s emissions are expected to end up, since only the latter incorporates information on the company’s management.

The Expected GHG Emissions Projection and Management assessment build upon the baseline, revealing how much of the company’s exposure is expected to be managed by the company. Both elements can be thought of as a measure of the company’s organizational preparedness through its investment alignment, governance, strategy, risk management, financial strength, and historical performance. These are all critical aspects of the rating that transcend the company’s ambitions, and instead give a full picture of the company’s preparedness for a Low Carbon Transition.

 

Expected GHG Emissions Projection

The Expected GHG Emissions Projection is calculated by combining the company’s Management Score (see description below) with the company’s Baseline GHG Emissions Projection. In this way, it acts as an adjustment to baseline emissions to illustrate the amount of emissions that the company is expected to manage through its investments and management preparedness.

The starting point of the adjustment is a Management Score, ranging between 0 and 100. A score of 50 implies that the company will not manage any of its emissions. Any point higher or lower than 50 equates to a 2% reduction or increase to exposure, respectively. A company that scores 100 is expected to manage all of its emissions because 100 is 50 points higher than the value of 50. Projected Emissions are calculated for each scope—Scope 1, Scope 2, Scope 3 Upstream, and Scope 3 Downstream—by region for each company and combined to give an overall projection.

Exhibit 5 illustrates the emissions gap between a company’s emissions budget and the company’s projected emissions.

 

Exhibit 5: Projected Company Emissions Versus Baseline Emissions


 

 

 

Management Score 

The Management Score is calculated for each Scope of Emissions, based on a set of management indicators which have predetermined weights set for them based on their subindustry. In total, Sustainalytics employs more than 80 management indicators. However, in many cases not all indicators are relevant for each company. In cases where an indicator is usually relevant for a subindustry but not relevant for a specific company in that subindustry, the non-relevant indicators are disabled, and the weight is evenly distributed proportionally amongst all remaining indicators to ensure that the combined weight of indicators within any scope always adds to 100%.

In exhibit 6, we see that a company has a Management Score of 66, as determined by scoring on its indicators. The score of 66 for the example company can be further explained as leading to a -32% Management Adjustment to baseline emissions, based on the approach whereby each point above 50, translates to a 2% reduction in emissions as compared to the Baseline GHG Emissions Projection.

 

Exhibit 6: Example of Determining Company Management Score for Scope 1 Emissions

 
 
Indicator Name
 

Score

 

 

Weight

 

 

Weighted Score

 

Investment Alignment - Scope 1 92 50% 46
GHG Performance Targets 0 10% 0
GHG Risk Management 75 8% 6
Carbon Price Integration 0 10% 0
Scope of GHG Reporting 100 5% 5
GHG Emissions Targets 50 10% 5
Operating Performance 50 2% 1
Solvency 75 2% 1
Financial Flexibility 75 2% 1
Asset Performance 25 2% 0
Management - GHG Scope 1 100% 66



 

 

Low Carbon Transition Rating Calculation 

The final rating outcome brings together the Exposure and Management components, to give an overall implied temperature rating known as the Low Carbon Transition Rating. This rating is calculated as the difference between the company’s Cumulative Expected GHG Emissions Projection and its Cumulative GHG Emissions Budget, which is for the period cumulative to 2050. The difference between these two figures is known as the Cumulative Expected GHG Emissions Gap Percentage.

 

Exhibit 7: Expected GHG Emissions Versus GHG Emissions Budget


 

 

The Cumulative GHG Emissions Gap Percentage is then used to translate to an overall temperature rating using the Implied Temperature Rise calculation formula noted in a previous section.


TCFD Module 

The Taskforce of Climate-Related Financial Disclosure (TCFD) is a globally recognized framework to improve and increase reporting of climate-related financial information. The TCFD contributed significantly to the design of the Low Carbon Transition Rating, particularly through the design of management indicators which align to TCFD recommendations. Although not the main output of the Low Carbon Transition Rating, the rating includes a separate TCFD module that explains how sufficient the company’s disclosure is in meeting TCFD recommendations.

 

TCFD Disclosure Sufficiency

At its core, TCFD Disclosure Sufficiency explains how comprehensive the company is in reporting on topics recommended by the TCFD. Since not all Sustainalytics indicators are based on TCFD recommendations, the first step is to identify whether each indicator is expected to be disclosed upon based according to the TCFD.

Following this determination, the module calculates how many of the recommended indicators the company is expected to disclose upon on and how many of those expected indicators were actually found by analysts in the company’s publicly available reporting.

The relative difference between the amount that were expected and disclosed upon and the amount expected, represents the company’s disclosure sufficiency. Note that the calculation is agnostic to how well the company is reporting on each topic but simply considers whether the company is reporting on the topic.

Exhibit 8 provides an example of how this works in practice for a company with a limited set of five indicators researched by Sustainalytics. For this specific company, it is expected that the company disclose upon 3 indicators but of those 3 indicators, the analyst only found disclosure for 1 indicator (Carbon Leadership Talent). As such, this company’s disclosure sufficiency is 33%. Note that even though the company reports on Positive Climate Policy Engagement, this does not contribute to its TCFD Disclosure Sufficiency score because this indicator pertains to a topic that was not recommended by the TCFD.

 

Exhibit 8: Example of calculating disclosure sufficiency

Indicator

Expected

(1 = yes, 0 = no)

Disclosed by Company

(1 = yes, 0 = no)

Expected & Disclosed

(1 = yes, 0 = no)

GHG Performance Targets 1 0 0
Carbon Leadership Talent 1 1 1
Positive Climate Policy Engagement 0 1 0
GHG Risk Management 0 0 0
TCFD Alignment - Financials 1 0 0
Total321
Disclosure Sufficiency1/3 = 33%  

 

 

Additional Details 

Scope of Emissions

Fundamental to all calculations of each budget and projection is the principle that emissions budgets and projections are calculated separately for each Scope of Emissions. This is to account for diverse business models that have varying splits of emissions between the different scopes. For example, a company may be expected to reduce its Scope 1 emissions by 12% in 2022, while its Scope 2 emissions are expected to decline by a modest 8% in the same year. One of the benefits of assessing each scope separately is that it allows us to create more insights into the areas where the company may be excelling or falling behind.