In early 2022, the US Securities and Exchange Commission (SEC) announced a new rule planned to go into effect by the end of the year. The ruling requires publicly traded companies in the US to report Environmental, Social, and Governance (ESG) factors. Furthermore, publicly traded companies must also include these factors in their supply chain. Therefore, most companies will be affected by this new rule. So, if you’re thinking, “this doesn’t affect me because I’m not a large publicly traded company,” read on to find out how you will be affected by these reporting requirements.

What is ESG and Why Is It Important to Investors?

ESG stands for Environmental, Social, and Governance. Companies report ESG factors to disclose consistent, comparable, and reliable information to their stakeholders about these issues. To investors, awareness and reporting on ESG factors are synonymous with risk mitigation. In the following list, I provide some examples.

Environmental

• Carbon emissions;
• Energy efficiency;
• Natural resource use;
• Waste; and
• Other environmental sustainability initiatives

Social

• Workforce health and safety;
• Diversity;
• Data security;
• Privacy policies;
• Employee training; and
• Community programs

Governance

• Business ethics;
• Board diversity; and
• Management policies

Digging Deeper Into Carbon Emissions

One of the aspects of the new SEC reporting requirements that will send a shock wave through the supply chain is the reporting of carbon emissions. In addition, the new rule requires the disclosure of not just the reporting company’s emissions but also the emissions associated with their supply chain.

Classifications of Emissions

When discussing carbon emissions and greenhouse gas reporting, you will hear the terms, “Scope 1 Emissions, Scope 2 Emissions, and 3 Emissions”.

• Scope 1 – are the direct emissions from the reporting company’s facilities and their company vehicles.
• Scope 2 – are the indirect emissions from purchased electricity, steam, heating, and cooling associated with the operation of the reporting company.
• Scope 3 – are the indirect emissions from all upstream and downstream activities. These upstream and downstream activities include all the companies associated with the reporting company at any point in the supply chain, including:
  • Purchased goods and services;
  • Capital goods;
  • Transportation and distribution;
  • Waste generated;
  • Processing of sold products;
  • Use of sold products; and
  • lastly, End-of-life treatment of sold products.

While this list isn’t all-inclusive of Scope 3 Emissions, it represents the categories most relevant to our clients.

Taking a Broad View of Emissions

A broad view of emissions includes the entire product life cycle from cradle (raw materials from nature) to grave (end-of-life disposal or recycling). Therefore, emissions involve a lot of companies across an incredible breadth of industries and geographies.

Reporting on Scope 3 Emissions is considered vital by shareholders of large publicly traded companies. That’s because Scope 3 Emissions typically represent a more significant environmental impact than the large publicly traded company’s Scope 1 and 2 Emissions.

Large publicly traded companies are already reaching out to their suppliers to understand the carbon emissions of their operations. Likewise, those suppliers are demanding emissions information from their suppliers. This reach-back into the supply chain, all the way back to raw materials from nature, is how many small, privately-held companies will be involved in emissions reporting.

How Will This Impact My Company?

Typically, customers will indicate expectations from their suppliers regarding ESG or sustainability and specify what information they require. Requests can take on many forms. In the following list, I show some of the most common ones I see.

• Complete a survey asking questions about ESG-related topics;
• Establish and share quarterly reports on 3-5 ESG-related metrics that your company monitors;
• Identify 3-5 goals from the United Nations Sustainable Development Goals, on which your company will monitor and report;
• Become compliant with or certified to ISO 14001;
• Provide a Life Cycle Assessment (LCA) for the product or service you are selling; and
• lastly, Report on your company’s Scope 1 and 2 Emissions

When asked for this information, it’s crucial to take it seriously. Ignoring ESG requests and thinking it will go away has resulted in:

• escalation of the data requests to higher levels within the company;
• reduction in status on approved supplier lists;
• cancellation of orders; and
• as a result, even loss of that customer.

 

The Greening of Industrial Customer Specifications

Green Specifications have increasingly become a requirement along with traditional specifications like

• maximum dimensions;
• maximum weight; and
• required materials.

Common Green Specifications include:

• “percent reduction in carbon dioxide equivalent emissions and energy usage compared to previous models”; and
• similarly, another version sets a cap on a product’s carbon dioxide (CO2) equivalent emissions and energy usage.

Green considerations are more than CO2 and energy and include

• water usage;
• percent recycled content; and
• finally, the percentage of recyclable material.

While the above examples are quite common, there are many possible Green Specifications one might encounter.

Green Specifications and Life Cycle Thinking

Green Specifications include Cradle-to-Grave Life Cycle Thinking.  Cradle-to-Grave Thinking requires suppliers to consider the CO2 and energy usage of their suppliers. Supplier considerations include going all the way back to raw materials coming from nature.

On the customer side of Cradle-to-Grave, a supplier must consider the use, maintenance, and end of life of their product.  A supplier must think broadly, both upstream and downstream from their operation, to truly consider a life cycle perspective.

Many Industries and Companies of All Sizes Include Green Specifications

Green Specifications typically align with a company’s sustainability targets, as documented in

• ESG Statements;
• Corporate Sustainability Statements; or
• lastly, ISO 14001 initiatives.

However, in smaller companies, these specifications can result from their larger customers’ demands.

Historically, the transportation industry led the way with these specifications to improve gas mileage and reduce emissions. However, today, many more industry sectors like

• construction;
• pharmaceutical;
• food and agriculture;
• oil and gas; and
• lastly, tourism demand greener solutions.

Whether it’s the public, the shareholders, or the customers who are driving this transition, companies of all sizes and industries face these new specifications.

Get Ready to Think Green

Sharpen your green pencil to stay competitive whether you’re reacting to your customer’s demands or you’re being proactive. In conclusion, now is the time to think green.

Does a kWh of electricity result in the same environmental impact regardless of where we generate it?

In a previous article, we explained how an inventory of all inputs and outputs is necessary to conduct a Life Cycle Assessment (LCA).  In addition, we explained that the benefit of an LCA is to understand environmental impact.  We also demonstrated that for corporations with facilities throughout the world, it’s essential to specify the location.  Similarly, when inputs or outputs have various processing options, it’s essential to use the appropriate process option in the LCA model to get a valid and accurate result.  For example, electricity is a typical input to most facilities, while waste water is a typical output to most facilities.  In this article, we’ll look at two examples using electricity production and waste water disposal.

Electricity Production Considerations

First, let’s look at an example that demonstrates why it’s crucial to consider where we produce a kWh of electricity. In this example, we’ll use two of the commonly known midpoint impact categories of

• Global Warming (Climate Change); and
• Particulate Matter (Human Health – Lung Function).

The scenario modeled below is a factory with 470K sq ft of manufacturing floor space and 150K sq ft of office space.  We are assuming that the factory uses 100kWh/sq ft, and the office uses 20kWh/sq ft annually.  Therefore, the total annual consumption of electricity is approximately 50 million kWh.

Environmental Impact from a Global Warming Perspective

The point of the chart below is not that this hypothetical factory is using 50 million kWh of electricity. Instead, the illustration shows the environmental impact differing significantly depending on the location of this facility.

The chart above shows the midpoint impact category of Global Warming Air in kg CO2 equivalent. In this example, we see that India’s electricity production releases more than twice the CO2 equivalent compared to the United States’ electricity production.

Environmental Impact from Particulate Matter Perspective

The chart below shows the kg of 2.5 micron-sized particulate matter released in the air as a result of this amount of electricity production.

• China’s electricity production releases more than 25 times the amount of particulate matter air pollution compared to the United States’ production.
• India’s electricity production releases nearly 40 times the air pollution than the United States’ production.

Waste Water Processing Considerations

Next, let’s look at an example that demonstrates why it’s crucial to consider process details of inputs and outputs. In this hypothetical example, the factory is located in the US and produces 10,000 gallons of wastewater per weekday.  The critical consideration here is whether the sewage treatment plant that processes their wastewater sends their sludge output to be

• applied for agricultural benefit;
• landfilled; or
• lastly, incinerated for energy recovery.

In this example, we see in the chart above that from the perspective of the midpoint impact category of Global Warming

• the best solution is incinerating sludge for energy recovery;
• the second best solution is agricultural land application; and
• lastly, the least favorable approach is placing sludge in a landfill.

Conclusion

In conclusion, these two examples of electricity production and wastewater disposal highlight the importance of specifying location and process details for accurately modeling midpoint impacts and performing Life Cycle Assessment modeling.

The 3 Interconnected Pillars of Sustainability are;

1. Planet;
2. Profit;
3. and People.

In the last blog post, we looked at the Planet Pillar.  Now let’s look at the  Profit Pillar of Sustainability.

Profit Has Been Crucial Throughout History

Our companies and families all revolve around a healthy economy.  Whether we conduct our trade in direct exchanges of goods and services, trading beads, IOU notes, or any of the world currencies, humans have engaged in the practice of commerce for at least as long as written history (including cave art) has existed.  We buy the things we need, and we sell the items we have.

Adding environmental concerns has not removed the need for a business to be profitable. Therefore, profit remains an essential component of an analysis of sustainability.  If a product we use requires a mineral or material that is scarce, the laws of supply and demand increase the price to buy it until it is no longer available and can’t be purchased at any cost.

Why Bankers and Investors Are So Concerned about Sustainability

Banks and investors care about risks in their portfolios of investments.  They are looking at the complete

• upstream supply chain for the product in which they are investing including complementary products that are used side-by-side with the product in question; and
• downstream consumer chain including the complementary products that are used side-by-side.

The trend from years ago, where banks and investors were only looking at the direct supply chain and the direct consumer, are changing.

Crucial questions now include:

• Are any raw materials from nature in short supply, meaning that the price for that raw material will rise sharply, affecting the price point for the product?
• Are there pending regulations on water utilization or air emissions that will change the operational costs of the company?

Sustainability issues represent risks to investors. Therefore, more and more annual company reports are now reporting on sustainability.

In conclusion, the Profit Pillar of Sustainability considers the viability for

• consumers to continue to purchase the product at a price they can afford; and
• suppliers to continue to make the product at a cost that provides a healthy profit.

Sustainability has three interconnected pillars, namely

1. Planet;
2. Profit; and
3. People.

But what does this mean, and how does one measure or address each of these pillars?  Let’s first look at the “Planet” pillar of sustainability. The other components will be addressed in upcoming blog posts.

A common way to classify the features of planet Earth is to include

• Land;
• Air; and
• Water.

Sustainability scientists use these same terms to measure the health of the Earth. Here are some measures we might consider for these terms.

• Land Health
  • terrestrial ecotoxicity;
  • terrestrial acidification; and
  • land occupation.
• Water Health
  • aquatic ecotoxicity;
  • aquatic acidification; and
  • aquatic eutrophication.
• Air Health
  • smog formation; or
  • particulate matter.

What Is Life Cycle Assessment (LCA)?

Life Cycle Assessment (LCA) is one of the tools we use to estimate impacts on our planet or the environment.  LCA considers the effects of a process or product from cradle to grave, meaning that we consider all stages of the product’s life from raw material extraction from the earth to disposal or recycling.

The LCA process is frequently used by designers to assess the potential impacts of their designs.  You might have seen a company advertise that their new packaging material design saves x billion kg of carbon dioxide equivalent from entering the atmosphere.  Or, perhaps a company will advertise that their new manufacturing process reduces sub 2.5-micron particulate matter by x tons per year.  These are examples of statements companies make to communicate that they’re thinking about the Planet Pillar of Sustainability.

4 Critical Steps for Conducting an LCA Study

Step 1: Define the Goal and Scope of the Study

This step might sound simple and unimportant, but it is the foundation of the whole study.  Ensuring that the study is well-defined allows us to draw comparisons between equivalent solutions.

Step 2: Prepare an Inventory

In the manufacturing world, we think of this as the Bill of Materials.  But in addition to just the Bill of Materials to manufacture the product, we include all

• Upstream Materials and Transportation for movement of the materials until we have the inventory in terms of raw materials from nature,  and
• Downstream Materials and Transportation
  • of the product to the customer;
  • materials required during use;
  • maintenance and repair; and
  • finally, disposal or recycling.

We again define this in terms of raw materials from nature.
Create an Inventory Flow Diagram to show flows from nature to nature, including

• water;
• energy;
• raw materials;
• releases to land;
• releases to air; and
• lastly, releases to water.

The inventory and associated flow diagram for even a simple product can be quite complex.

Step 3: Perform an Impact Assessment

Each inventory item is associated with a potential environmental impact.  Summing all the potential environmental impacts for each inventory item provide an estimated quantification of impact.  Various software packages can assist with this assessment of impact.

Step 4: Interpreting Results

The final step involves interpretation of the results, performing sensitivity analysis on the data, and making recommendations.

So hopefully, the next time you see a company advertise that their redesigned product uses x million liters less water per year or their redesigned manufacturing process releases x million tons less particulate matter per year, you’ll have an idea about the analysis that they went through to define that estimate for impact on our planet.