We know how to measure carbon… Don’t we?

Amy Brachio (00:00) 

Hello. My name is Amy Brachio. I’ll be one of your speakers for today’s episode of Trading Thoughts, where we will be exploring carbon accounting.  

After retiring from a 30-year career at EY, where I retired as EY’s Global Vice Chair for Sustainability, I now lead Carbon Measures, a business coalition focused on aligning market incentives to the actions companies need to take to reduce carbon emissions. I also have the pleasure of working alongside the ICC and serving as the Co-Chair of the Technical Expert Panel focused on product level carbon accounting.  

I’m really pleased to be joined today by my fellow Co-Chair of the Technical Expert Panel, Karthik Ramanna. Karthik is Professor of Business and Public Policy at the University of Oxford’s Blavatnik School of Government. At Oxford, Karthik established the Case Centre on Public Leadership and the Transformational Leadership Fellowship, the latter a bespoke by invitation-only programme for senior leaders looking to reimagine their public service impact. In 2022, he co-founded the nonprofit e-Ledgers Institute, where he serves as principal investigator with a mission to drive innovations in energy efficiency through rigorous emissions accounting. 

Thank you, Karthik. I’m really excited about our discussion today. So, before we get started, you know, we’re talking about carbon accounting, and this is an area that you’ve been studying. Can you just give us your definition as we jump in? 

Karthik Ramanna (01:36) 

Yeah, first thank you so much for hosting me, Amy, on this podcast. And I’m absolutely delighted to join you on this ICC panel, in part because there’s been so much interest in this work from companies as a way to sort of drive their decarbonization. So, when we think about carbon accounting, just as we think about accounting more broadly, the most important thing is that it drives decision making in organizations. 

It’s not accounting for its own sake. It’s not accounting simply for external reporting – which is important – but it’s accounting largely for companies to be able to make choices in the way they source their inputs, in the way they design their operations and in the way they deliver their products to their customers.  

So that kind of information has to be real time or as close to real time as possible – what we might call dynamic rather than static. It needs to be specific to that particular batch, that particular facility, that particular set of inventory inputs and outputs. And it needs to be generated in a way that suppliers and buyers in value chains have incentives to actually exchange truthful information. So what we as economists call: it needs to be incentive compatible. Those are fundamental properties of accounting as we see it. And it’s again to drive decision making. 

Amy Brachio (02:56) 

Great. You know, one of the things that comes up a lot is what are the practical challenges? What you laid out can sound easy, but it’s harder in practice. And so maybe I can share what I hear from companies around those practical challenges. And I know you’ve worked with a number of people to test this, so would love to add on. 

And so what I hear is oftentimes people ask the question, why do we need this focus? Don’t people already understand how to do carbon accounting? And so, what do you see as the practical challenges that are getting in the way? And one of the things in our landscape review showed this: is that there’s quite a bit of fragmentation. And so it’s not that people don’t actually know how to do carbon accounting, it’s that there’s almost too many different ways to do it. And so you’ve got different industry sectors that have their approaches, you have different approaches tied to different regulations around the world. You have companies that have developed their own bespoke way of doing the carbon accounting.  

But one of the things that you talked about was decision useful. And so if something’s going to be decision useful, you need to understand how it was calculated. You also want to make sure that companies don’t have to calculate many different ways because of this fragmentation. And I remember talking to someone in business, who laid out that she has to calculate different calculations around the carbon intensity of her product for different customers because they prefer different methods. So, same factory, same process, same product, different numbers because of this fragmentation. So, what do you see as some of the practical challenges? 

Karthik Ramanna (04:48) 

Yeah, that’s a great observation and it’s spot on, Amy, right? And it highlights in fact this distinction between accounting and reporting, or between accounting and disclosure. The accounting system that we’re trying to build, you and I and the ICC team that’s come together in this Technical Expert Panel, is the underlying data that will then populate these various reporting systems, that will populate these various disclosure systems. It is the underlying primary information on the emissions associated with a given entity or a facility within that entity. It is the information again specific to the units of input and inventory that the entity purchases. And therefore, it is the information specific to the outputs that that entity or facility generates. And that’s the underlying accounting information.  

Now, there might be various formats in which that is reported. There might be a format in which that’s reported, for instance, to CBAM authorities, if you’re exporting into the European Union. There might be a format in which you report that, say, for instance, if you are reporting under the greenhouse gas protocol or some other disclosure mechanism. There might be a format that your investors choose to demand of you. There might be a format that your customers choose to demand of you. But if we get the accounting right, it’s the same underlying information that’s populating all of these various disclosure and reporting formats. So that’s the way I think we want to see this distinction in the context of these very real challenges that you’ve highlighted. 

Amy Brachio (06:15) 

Yeah, I see it as getting to like the GAAP or the IFRS so that you understand the rules and you can calculate once and use many times.  

So one of the things that you talked about was primary data. And I think that’s always the preferred approach. But when you’re talking about a large organization, maybe that’s something that they can get to, but they also need information from their suppliers. And those suppliers may not be large organizations and may not have the same resources to be able to do those calculations. How do you deal with that complexity across the value chain? 

Karthik Ramanna (06:53) 

That’s also a really important observation. And as you mentioned earlier, we’ve done a number of pilots with companies in cement and steel, in energy, in automotive, tire and rubber manufacturing. And so this was a challenge. Imagine, for instance, if you’re the first company in your country or your sector to be taking this approach and you have hundreds of suppliers, where do you even begin? Right? So, one of the challenges that companies face is this question of, you know, how do you boil the ocean when it comes to this primary data? And a practical way in which we’ve approached this is some version of what we’d call the 80-20 rule, right? 

So, one of the first companies we worked with was a tire company in Indonesia, one of the world’s largest tire companies, Giti Tire. And they had this problem where they had hundreds of suppliers, and they said, okay, do we now ask all of these suppliers to start providing primary data? And what about their suppliers? That becomes then very quickly thousands of you know tier two suppliers. And so we said, okay, well, before we start doing all that, why don’t we just see what are the key inputs that you think really matter, just at an intuitive level, for your emissions? And in their case, it turned out that there were four: there was carbon black, steel cord, synthetic rubber and natural rubber. These are the four really intuitively emissions intensive inputs into tire making. So they contacted their four suppliers for these four key inputs and they said, hey, would you on a pilot basis work with us to give us kind of like just primary data from the facilities that supply us, that support us, just for these two months of this pilot?  

And guess what? Three of the four suppliers said, sure, we’ll give it a shot. One said, you know what, we’re really busy. That’s okay. It’s fine. We started with those three. And, you know, but it turned out that those three accounted for about 65% of the tires weight. So, right, it was a good place to start. And then, of course, we calculated the primary data for the tire facility in Indonesia itself. And we were able to get, therefore, an output for the tires produced by that facility for that particular reporting cycle, which was, you know, over two months, we were able to do that. 

And guess what? When they took that information to their customer – a very large automotive company – the customer said: this is great, this is exactly the kind of thing we want. But guess what? We don’t quite want only three suppliers. We want 12 suppliers that come closer to 90% of your tires’ weight. But now that they had this sort of pressure almost, this incentive from their top customer, one of the world’s largest car makers, they went back to those suppliers and they said: hey, so we’ve had this successful pilot, can we now get you to participate? And guess what? They were able to go up to twelve suppliers, right? So, it’s that iterative process, that recursive process that kicks this into gear. 

Amy Brachio (09:46) 

Yeah, and I think we mentioned that we Co-Chair this Technical Expert Panel. The beauty of the technical expert panel is the diversity of views and perspectives. And I know you and I don’t have all the answers as we look at how you bring this to scale, but we have a number of members of the panel who are consistently saying: now, how are we gonna enable small and medium-sized enterprises to be able to bring this forward? And what type of knowledge transfer is required in order to enable that? And so, I think it’s a challenge that we’ve both seen examples of how it can be addressed, but now it’s how do we get it addressed at scale?  

One of the things that you also mentioned earlier was around CBAM compliance. And I think, one of the questions also that often gets asked is why is this attention needed? And one of the things that we’re seeing as we look around the world is that policymakers are putting out new policies that focus on product level emission standards. And in different parts of the world, they’re pointing to different ways to do those calculations. And so I think that as more and more of this data is being used for regulatory compliance and for market differentiation, it will become more of something that’s a requirement of suppliers and less of something that is optional. What’s your view on that? 

Karthik Ramanna (11:14) 

Yeah, I think that’s absolutely right. And as it becomes written into regulation, as it becomes the basis, I mean CBAM is a form of a tariff or a tax, right? And so you can’t have a tax on sort of you know, industry average data. You need it to be on specific primary data that’s batch specific, entity specific, product specific. 

And so, once we start looking at these sort of regulatory applications, whether it’s for a product intensity standard, whether it’s for a carbon border assessment, the need for this kind of underlying accounting system that generates primary data becomes central, right. So that actually is almost what we’ve called the pull factor to bring this into sort of wide-scale and widespread adoption. 

And I think that’s useful because of course, when you’re complying with sort of regulations rather than engaged in voluntary disclosure, then different standards of liability apply to the information that you report. And therefore, the need for this kind of primary data, the need for this data to be assured by, you know, qualified assurance providers, et cetera, that becomes really important as well. But of course, once you start having this information in value chains, once companies start producing this, whether it’s for regulation or some other kind of you know public mandate, customers in those value chains start demanding it on their own, right? So there becomes this sort of almost organic market demand that comes in from the regulation.  

If you think about the analogy to GAAP, or Generally Accepted Accounting Principles, GAAP was created to meet a regulatory mandate. The Securities and Exchange Commission was set up by the US Congress. They decided that we need this thing called GAAP, et cetera. It was there very much with to meet a regulatory mandate. But now it’s used widely outside those regulatory applications. And in fact, there’s been work that has shown that the scale of US capital markets increased almost 100-fold with the introduction of GAAP, right? Because information supply creates its own demand. 

And suddenly people are like, wait a minute, I want this, I want that information, I want to be able to compare. I can put more capital into this project, right? Whole industries like passive investing, like Vanguard and things like that, were created on the basis of something like GAAP. These were almost quote on quote unintended consequences to this kind of regulatory pull. And we’re hopeful and expecting this kind of, sort of market effect to follow up with the kind of regulatory pulls that you described. 

Amy Brachio (13:42) 

Yeah. One of the things… Carbon Measures, what we’re really focused on is how do you align market incentives to the actions that companies need to take to drive down emissions. And we think in order to do that, that you’ve got to have smart policy that drives demand so that companies have a benchmark they have to hit that goes down over time. But you can only do that if you can compare my product to your product. And both the regulators understand it’s compliant, but also that those in procurement can make a purchasing decision between the two. And so I think that’s another argument for why this is now needed.  

Now, one of the things, you know, I had mentioned earlier that one of the challenges is fragmentation. And then you say, well, if you see a challenge as fragmentation, why are you looking at this again? Is this not just going to cause more fragmentation? And so one of the things that I know we both think is really important is interoperability. And so maybe say a little bit about how you see that coming into play. 

Karthik Ramanna (14:50) 

Yeah, that’s exactly right. So, if you take something like EPDs – Environmental Product Declarations – that are mandated of companies, particularly in certain sectors and jurisdictions like Europe, et cetera, also in the building sector more globally, if you take applications like reporting under the Greenhouse Gas Protocol, which is widely embraced by many companies on a voluntary basis, these are applications where the provision of this kind of primary data becomes an enabler to scale, right?  

In fact, the Greenhouse Gas Protocol very much recognizes the problem we’re trying to solve by saying the best-case scenario is primary data. We want primary data. So, this solution is a way to supply that primary data into the value chains, so that you don’t have to make an estimate or a guess on what are your supplier-suppliers’ emissions or your customers-customers’ emissions, et cetera? You now have an information mechanism that provides that to you, so that you can report your direct emissions, your energy-related so-called scope two emissions, your upstream and downstream emissions. You can report these kinds of things in the context of primary data.  

Ditto with your EPDs, your Environmental Product Declarations, suddenly you have great data to report them. You can actually get a reasonable assurance opinion as opposed to a limited assurance opinion, which is of course something very relevant from your previous role in an audit firm. 

Amy Brachio (16:17) 

Absolutely. How I look at this is that you need different data to make different decisions. And if we compare it to financial accounting, you’ve got a balance sheet, you’ve got a cash flow statement, and you’ve got an income statement. And no one is saying you have to pick one of the three. You need them to go together and the math works between them. And so what we’re looking at is that ledger at an entity level that allows for information to be able to be passed across the value chain. 

So, I think in this discussion, that is the first time that either of us have said the word ledger. And a lot of what we focus on is the importance of ledger-based accounting. So, tell us a bit about that. 

Karthik Ramanna (16:59) 

Yeah. The ledger is basically the key innovation, by the way, in financial accounting as well, right? This goes back to Luca Pacioli and the invention of double entry bookkeeping, which was kept on a ledger. And in fact, Goethe, who is this sort of great German philosopher from about five hundred years after the time of Luca Pacioli, goes on to say this is one of the quote on quote finest inventions of mankind, which is, you know, when I say, well, when someone with an accounting background says that, people will say, well, that’s self-serving. But this is Goethe saying it, so… 

And that’s because double entry bookkeeping and the creation of the ledger, the financial ledger in that case, was credited with the invention of modern capitalism. Many historians of capitalism have made this point, including Jacob Soll, who won the MacArthur Award for his book The Reckoning that looks at the origin of accounting across societies. Niall Ferguson has written about this as well. So, this is sort of a widely accepted sense that this kind of ledger is the foundation of great record keeping, which is then the basis of you know a complex market society where you can separate ownership and control and you can get scale and things like that.  

So, at the heart of the carbon accounting transformation that we’re seeking to drive is this ledger. And this ledger does a few things that are really important. The first thing it does is it serves as a place to store or archive direct emissions. Because once that direct emission is incurred as a result of some say process that you’re conducting in your facility, it sits on that ledger and it cannot be destroyed until it is sort of allocated to a product. And then when that product is sort of sold or transferred in the value chain, it moves with that product through the value chain. So, once the emission record is created, it cannot be destroyed. And this is, in some sense, the beauty of the double entry bookkeeping system. And it mirrors the first law of thermodynamics in chemistry, which is energy cannot be created or destroyed. Mass, therefore, too. Material balancing is what the chemical engineers on our panel would call it.  

The second sort of feature or value of the ledger comes from the idea that it basically allows or forces you to allocate all of your incurred emissions to your outputs. It says no company is incurring emissions for fun, at least we hope it’s not, and so if you’ve incurred these emissions, there must be a legitimate sort of economic purpose for it, so let’s find a causal route to allocate it. It’s just like the principle of full costing you see in financial accounting. If you’re a business that can’t cover your costs, you very quickly go out of business. So that’s the second thing that the ledger enables.  

And the third and perhaps most important thing that the ledger enables, is what we call the incentive compatible transfer of data. Because when you, as the supplier, transfer your inventory to the buyer, the buyer takes on the associated emissions, right? So the buyer has to now say: wow, I’ve got this emission sitting on my ledger, so I start shopping around to say who’s the best seller in this market that will give me the quality I want, give it to me at the cost I’m willing to pay, give it to me at the timeliness that I demand, but will lower this emissions that I have to carry on my ledger. So, it creates this incentive compatibility in the system.  

And so it’s these three things that, by the way, all borrow from the beauty of double entry bookkeeping and financial accounting, right? The basis of modern capitalism. These are the three things we’re talking about, when we talk about the ledger, that then enables all the disclosure systems, et cetera, that are already out. 

Amy Brachio (20:36) 

Yeah, I think it also, it helps to make sure that you’ve got completeness, that you’re capturing all the emissions associated, and in applying materiality, that those emissions aren’t materially over- or understated. And that helps with driving the trust behind the information. 

So Karthik, when you look forward, all of the work that we are doing around carbon accounting, what do you hope that that does to help change the future and ultimately drive down emissions? 

Karthik Ramanna (21:10) 

Yes, so I got into this about five years ago in part because I was motivated by the issue with too many moles of CO² in the atmosphere. That we have a problem where the planet is warming, and it’s warming as a result of anthropogenic activity that emits CO² and other greenhouse gases into the atmosphere, right? So that’s kind of why I got into this.  

But as someone who has taught in business schools and who, you know, comes from a sort of a tradition of economics, I recognize that the reason we have these moles of CO² in the atmosphere is because of economic activity. 

So, I am an American, I live in the UK, but I was born in India. And I was born at a time in India before India embraced economic liberalization, when it was relatively a very poor country. And then in the early 90s, India did open up its markets, and as a result, has grown substantially over that, and it has lifted hundreds – the embrace of market capitalism has lifted hundreds of millions of people out of poverty in India. If you then look at the similar story in China, in Indonesia, in Sub-Saharan Africa, in Latin America, billions of people have been lifted out of poverty by the pursuit of economic progress. Of course, it’s that economic progress itself that has created this climate problem.  

So one of the things that this accounting system is trying to do is to, in some sense, balance these two things. We can’t abandon all this progress. And of course, hundreds of millions of more people want to go into middle class lifestyles: they want to be able to buy cars and air conditioners, they want to take travel, you know, vacations to foreign destinations, et cetera. And we want them to have that flourishing life that you and I and so many others enjoy. But we need to do it in a way that companies are rewarded, when supplying products to meet that demand, but supplying them in a way that actually reduces emissions. So, the vision we are moving toward is an economy that, in the words of an economist, endogenizes emissions reduction into the meeting of economic demand and that’s what a real robust carbon accounting system does. 

Amy Brachio (23:15) 

Yeah, when I look forward, I think about there are policies out there and ways of looking at things from other parts of society that I want to make sure that we’re adopting to help solve this really big problem. And so, when you look at some of the policies that were out there on product level regulation, they have worked. We got sulphur out of diesel, to address acid rain, we addressed the issue with the ozone layer with requirements around products and I think we need to do the same for carbon emissions. Especially those early in the value chain that drives the bulk of the emissions.  

But you certainly can’t do that if you can’t compare one product to the next. So when I look for it, I think about it in sort of simple terms. Like when I travel a lot and I buy a bunch of protein bars. And when I’m buying a protein bar, I look at the calories, I look at the flavour, and I look at the protein content. And I want it to be that when a procurement officer is buying these goods, that they are looking at access to the product, quality of the product, price of the product and the emissions associated with that product and then I think you can unlock markets to drive change.  

Well Karthik this time has flown by so thank you so much for this really engaging conversation. 

Karthik Ramanna (24:35) 

Thank you, Amy, but can I ask you one question before we go? Which is: so, suppose people who have heard this podcast are interested in engaging with us and this project that we’re sort of conducting, how can they contribute? How can they reach out? What is the best way for them to engage with this project? 

Amy Brachio (24:57) 

So, the ICC website lists out all the work related to the Technical Expert Panel and our publications. And there’s also a link there that if people have feedback, they can provide that feedback. And that’ll come to both of us, and we’ll make sure that we get it in front of the Technical Expert Panel. And so with that, I will thank you for participating. And I want to thank everyone who listened to this for your time and your interest in carbon accounting. 

Karthik Ramanna (25:28) 

Thank you.