Carbon Accounting vs Climate Risk: What's the Difference?

In my work, I have noticed a critical skill and knowledge gap linked to Task Force for Climate-related Financial Disclosures (TCFD) Reporting. Many sustainability professionals I’ve worked with conflate TCFD Reporting with carbon accounting. However TCFD’s reporting recommendations extend well beyond carbon accounting. It also calls for climate risk reporting, which is quite different from carbon accounting.

In my experience, very few sustainability professionals have a strong understanding of climate risk. I first learned about these considerations by working for a platform that specialized in scenario analysis and quantifying climate risks in financial terms and then enhanced my knowledge with a Sustainability and Climate Risk professional certificate offered by the Global Association of Risk Professionals.

I scored among the top quartile (results only measured in quartiles) for the topics: climate risk, climate risk assessment and management, and climate models and scenario analysis, among others. These are all critical elements of TCFD reporting. Given that TCFD reporting is becoming mandatory in many regions of the world, sustainability professionals and executives seriously need to level up. This article aims to address some of those gaps.

Carbon Accounting Basics

In simple terms, carbon accounting is a lot like financial accounting. For every action an organization takes an associated CO2 “credit or debit” can be accounted for in a double ledger report. The Carbon Disclosure Standards Board traditionally helped develop standards to control this area. To effectively conduct carbon accounting, you need to accurately apply internal checks and balances to avoid double counting and use discrete categories of emissions to capture the total source types. “Carbon emissions factors” help organizations translate their activities into measurable quantities of CO2 equivalent emissions to understand the climate impact of business activities. 

Global carbon budget

Carbon accounting is a way to demonstrate carbon emissions reductions using scientific measurement. Absolute emissions reduction is arguably the primary way for businesses to align with the Paris Agreement. using the concept of a global carbon budget. This is scientists’ prediction of how much CO2 or equivalent (CO2e) emissions we can add to the atmosphere before reaching the threshold of an average global temperature of 1.5 degrees Celsius. Carbon budgets are not verifiable or exact, nor is the threshold of the Paris Agreement a guarantee of “safe” conditions, but it is the globally agreed figure we’re aiming for. Achieving global Net-Zero emissions by 2050 is the pathway that has been modeled to achieve this threshold.

Emissions Scopes 1, 2, and 3

Carbon accounting is obviously necessary to ensure we’re on track. It follows the guidelines of the GHG Protocol, which classifies emissions into three main categories for different commercial entities: Scope 1 (operational), Scope 2 (emissions from purchased electricity/fuel), and Scope 3 emissions (emissions generated from 15 categories of upstream and downstream sources linked to businesses operations). To collect the necessary data for all of these categories, businesses often have to engage departments across their entire organization in carbon accounting.

Measuring absolute vs intensity emissions

Within carbon accounting there are different ways of measuring carbon emissions. “Absolute emissions” are the simple sum total of emissions, while “intensity emissions” are measured in a proportional relation to the level of growth a company is undergoing. With intensity emissions, however, your overall percentage of CO2 emissions per dollar of revenue earned can decrease, while your absolute emissions can still increase. This is why many investors increasingly demand organizations report their absolute emissions in addition to intensity emissions and set targets based on absolute emissions.

What’s next for carbon accounting

Investors and regulatory bodies are giving increasing importance to carbon accounting over time. Organizations increasingly need to present their carbon emissions reports along side their financial statements. In the future, it could become as commonplace as tax preparation within organizations.

Climate Risk BASics

Climate risk is another animal entirely, though people often assume it’s closely linked to carbon accounting. Instead, climate risk evaluations consider the financial losses that could incur due to direct climate-related hazards in addition to indirect socio-economic changes linked to climate change that have financial implications.

These are classified as direct “physical” climate risks from acute (floods, hurricanes, wildfires, extreme weather events, etc) and chronic (drought, sea level rise, average temperature change, etc) climate impacts and “transition” risks linked to policy change, litigation, technology change, and reputation risks related to consumer preferences associated with climate change.  Climate risk assessment also considers the opportunities associated with these, but the risks often far outweigh these opportunities for most traditional business models.

Attribution science

Starting with the direct “physical impacts,” it is important to keep in mind that we have the means to measure how much climate change contributes to the intensity of natural disasters. This enables a science-based attribution of the financial losses from these events to climate change, too. Scientists are also now capable of modeling attribution to determine the percentage of ever natural disaster that we can attribute to climate change. What they’ve found is that climate change impacts are worsening at a faster pace than expected from earlier climate models. 

Predictive analytics

This fact means that climate impacts today are just a sliver of what’s to come unless we drastically reduce emissions. Intensifying climate risks more or less align with intensifying social instability and financial risk for the global economy. Given the accelerating rate of climate impacts in frequency and intensity (for both acute “events” and long-term “chronic” trends like sea level rise), businesses need to deal with future potentials to effectively assess these risks. Historic data analysis alone does not account for this change, so climate scientists also use predictive analytics to model climate impacts.  

Accounting for externalities

Climate risk helps assess the “true cost” of climate change today, while understanding the climate “economic bubble” of overvaluing assets based on the future potential of climate change. This paradigm has the potential to create systemic economic risks and it impacts almost every domain of the economy. To date, the negative financial impacts climate change creates (which far outweigh any positives) have been largely ignored by banks and businesses. The TCFD and the Network for Greening the Financial System were created to address this issue across global economic systems. 

TCFD Reporting

What does this mean for business? Climate change impacts directly transmit to measurable financial losses and financial risks. These include insurance risks, pricing risks, market risks, credit risks, and others. The fact is, most banks and insurers have been using a shoft-term lens to evaluate the long-term impacts of climate change. The TCFD is a climate risk reporting framework designed to address this gap.

TCFD is broken down into four pillars for reporting: Governance, Climate Risk Measurement and Assessment, Business Strategy, and Metrics and Targets. Within these categories, businesses should disclose their governance structure and climate risk oversight, climate physical and transition risks and management approaches, business strategy approaches using scenario analysis, and Scope 1, 2, and 3 (recommended) emissions measurements and targets.

Climate risk assessments are largely conducted at the executive level with the involvement of the Chief Financial Officers and Boards of Directors. They form part of an ERM framework, folding the resulting financial considerations and plans into an overarching business strategy.

Scenario Analysis

The ways TCFD requires businesses to explore future potentials using scenario analysis are very compelling to me. Scenario analysis is a heuristic, a technique used to explore potentials. It helps businesses, banks and financial institutions come to grips with climate realities dragging down our economy.

What most climate risk scenario analyses suggest is that a high-warming scenario is vastly more expensive than a low-warming scenario. It also comes with far worse social impacts and general chaos. While this fact helps us prioritize actions, it doesn’t guarantee that we’ll achieve a low-warming scenario. Multiple political and social factors that continue to create structural barriers to action, so it is imperative to remove these barriers.

In a practical sense, though, it means organizations have to prepare for multiple possible scenarios (high and low warming scenarios), which lead to starkly contrasting future potentials, summarized by the IPCC’s Shared Socioeconomic Pathways. So scenario analysis links “if this then that” style thinking across short-, medium-, and long-term trajectories of warming trends, along with our expectations for their social and economic implications. 

As a literature major, scenario analysis really appeals to me, because it’s basically a “choose your own adventure” narrative exploration applied to a real-world historical condition we face today. Climate change is no short of an epic tragedy, already marked by fatal flaws, domino effects, and “what have I done” style thinking. I’m hoping we can rewrite the future to be series of close calls and momentum building that fundamentally shifts our society towards a low-risk future.

Minding the TCFD Gap

Sustainability professionals and executive leaders alike need to level up to better assess and report on climate risk. To this end, I highly recommend earning the Global Association of Risk Professionals’ “Sustainability and Climate Risk” certificate (unsponsored).

After earning this certificate, I had a much stronger understanding of how and why predictive analytics are critical to strategically planning for climate-related losses. It also helped me understand exactly how to capture these losses in financial risk assessments by analyzing how climate risk transmits into economic risk. It is a swiftly growing domain with very important implications. I highly recommend this certificate program.