Scope 3: No longer someone else’s problem

Tough new climate disclosure laws are putting pressure on companies to report on their Scope 3 emissions. While some challenges remain in making credible estimates, what really matters is that companies can demonstrate they have a plan in place to reduce them in line with net zero – showing by how much, and by when.

• Scope 3 emissions account for almost 90% of oil and gas industry emissions 
• Regulators are increasingly requiring full disclosure of companies’ emissions 
• North Sea operators face an ever harsher investment climate as banks and other institutions cut their ‘financed emissions’ 
• Scope 3 cuts require consistent measurement and a commitment to reinvention 

The UK’s North Sea oil and gas industry has come under scrutiny following the Government’s recent decision to approve new oil and gas licenses on the UKCS. Much of the attention of campaigners has been the eventual carbon emissions that will end up in the atmosphere once the barrels of oil and gas are burnt – so-called Scope 3 emissions. Chief amongst their arguments is the charge that the development of new fields underneath the North Sea is not consistent with the UK’s Net Zero commitment, enshrined into law in 2019. 

Yet it’s clear that the UK’s upstream oil and gas sector has made significant progress in cutting its Scope 1 and 2 emissions – those from owned or controlled sources, as well as indirect emissions from the purchase of energy such as electricity or steam. UKCS emissions have declined by almost one-quarter between 2018 and 2022, while the carbon intensity of the oil and gas extracted has also declined.  

Scope 3 includes all the other indirect emissions that occur in a company’s value chain and typically account for three-quarters of a company’s emissions, according to estimates from the CDP. This proportion varies considerably by sector and can vary from as low as 16% of a company’s emissions for the cement industry, and approach 100% for firms involved with transport, capital goods and financial services.

The oil and gas industry sits towards the high end of this range, with the CDP estimating that Scope 3 represents around 89% of total industry emissions. 

Regulation tightens the knot 

New laws introduced in January 2024 require companies operating in the European Union to start collecting and then disclosing a wide range of information relating to their environmental and social impacts. The EU’s Corporate Sustainability Reporting Directive (CSRD) requires firms to report on their Scope 1 and 2 emissions, but most notably it also mandates the disclosure of their Scope 3 emissions too.  

The UK Government is also considering whether companies should be mandated to report and be made accountable for their entire supply chain emissions. In October 2023 the Department for Energy Security and Net Zero (DESNZ) launched a call for evidence to examine the practicalities involved with Scope 3 reporting. 

The existing Streamlined Energy and Carbon Reporting (SECR) regime in the UK imposes various GHG emissions reporting requirements on quoted companies, and large companies. The SECR requires companies to disclose their Scope 1 and 2 emissions, though Scope 3 emissions are currently voluntary. The UK Government is due to publish their response to the consultation before the end of March 2024. 

Elsewhere in the world, the Australian government is expected to introduce regulations in July 2024 that require all large companies and financial institutions to disclose their climate impacts, including their Scope 3 emissions. Meanwhile, companies based in California will need to comply with supply chain emissions reporting requirements from 2026, while rules affecting listed companies across the USA are expected to be published in April by the Securities and Exchange Commission (SEC). 

‘Financed emissions’ under scrutiny 

The direct impact of regulation on North Sea producers is important, but the most immediate impact may be happening already – albeit indirectly – from the sector’s investors. 

In early 2024, a group of 27 institutional investors in Shell, including UK Government-backed National Employment Savings Trust (Nest), agreed to back a resolution urging the oil company to set Paris aligned targets that tackle its end user Scope 3 emissions. Shell has set interim 2030 Scope 1 and 2 absolute and intensity-based emission reduction targets but has shied away from making similar commitments on Scope 3. The resolution put forward by shareholder activist group Follow This will be voted on at the company’s annual general meeting in May.  

The action reflects broader concern from financial institutions, who are also under pressure to account for and reduce their own Scope 3 ‘financed emissions’. Almost two-thirds of bank financing for fossil fuels is a result of underwriting, which according to the Partnership for Carbon Accounting Financials (PCAF), “exerts [a] material impact on the direction of capital towards economic activities that will allow the transition to net zero no later than 2050”.

The focus on Shell is significant given the importance of its activities in the UK North Sea. According to the supmerajor, it produces approximately 10% of UK oil and gas from more than 50 interests in North Sea fields, 30 North Sea platforms, a floating production vessel operated on its behalf.

The extent to which broader concerns over ‘financed emissions’ are being felt by the UK oil and gas industry began to emerge during the summer of 2023. The Treasury held a meeting during August aimed at encouraging banks to help finance operators in the North Sea. Several financial institutions were invited to attend, but it appears that many snubbed the Treasury’s advances.  

Many finance houses had already pulled back from the North Sea after the UK Government introduced the Energy Profits Levy (EPL) in May 2022. Several financial institutions have since announced new restrictions on their ‘financed emissions’, with HSBC, BNP Paribas, ING, Crédit Agricole, and Natwest among the banks that have stated that they will stop financing new oil and gas projects, including those in UK waters.  

Although the largest companies operating in the region have significant financial resources at their disposal, the majority of UKCS operators are small and must rely on favourable lending terms from banks to help finance their projects.  

The irony of course is that the pullback in funding may adversely affect those North Sea operators looking to decarbonise their upstream operations, were they able to access financing to do so. 

A measured approach 

Whether North Sea producers are feeling Scope 3 pressure from regulators or their investors, the first stage for any company looking to manage their Scope 3 emissions is to measure them.  

The GHG Protocol – an international standard for corporate accounting and reporting emissions – is the place to start. Originally published in 2011 the Scope 3 Standard remains the only recognised method for companies to account for their supply chain emissions. 

The Standard breaks Scope 3 emissions down into 15 categories. Eight of these are focused on the upstream value chain, with seven to the downstream. The CDP estimates that 81% of oil and gas industry emissions fall under Category 11 – ‘Use of sold products’, 3.6% under Category 1 – ‘Purchased goods and services’, and the other 4% of Scope 3 emissions covered by activities not accounted for under Scope 1 and 2.

A September 2022 report from DNV examined the Scope 3 challenges faced by Norwegian oil and gas operators. The responses indicate that ‘use of sold products’ is relatively straightforward for such companies to calculate, given that sales data or equity-based production volumes is part of standardised financial reporting.

The perception among those companies surveyed was that the other 14 categories are significantly more difficult to calculate. However, given that they only account for 8% of overall emissions the priority for any oil and gas company is to estimate their Category 11 emissions in a consistent manner. 

Nevertheless, despite their optimism, oil and gas companies still need to make some rather large assumptions about how consumers use their products – and it’s here where differences can arise. For example, the International Energy Agency’s (IEA) refinery product benchmarks yields are often used to estimate emissions in different geographies, even when more accurate individual refinery output data is available.  

DNV also points to the variation in the composition of natural gas sold as an uncertainty when estimating emissions associated with the ‘use of sold products’. Finally, the report also highlights how many energy companies exclude non-energy products (e.g., petrochemicals) from their ‘use of sold products’ emission calculations.  

Analysis by Carbon Tracker published in September 2023 reveals that Eni, TotalEnergies, Repsol, and BP are the only companies that have net-zero goals and absolute interim targets covering Scope 3 emissions. Moreover, their analysis indicates that none of the world’s largest oil and gas companies have set emission reduction targets that are aligned with Paris.  

Some companies point to the challenges highlighted above, coupled with the argument that emissions could be double counted as a reason not to set Scope 3 targets. However, that misses the point. What matters when it comes to industries aligning towards net zero is that they have a plan in place to reduce them, by how much, and by when. 

Scope 3 cuts require reinvention 

The primary path available to those individual companies that have committed to cutting their Scope 3 emissions is to dramatically reduce production of oil and gas. However, this action alone is not sustainable, clearly both for the business, but also for the climate.  

Simply cutting oil and gas output alone gives those operators that have not committed to ambitious emission reduction targets a free pass to hike output, potentially at the expense of higher Scope 1 and 2 emissions. 

The only course of action that is going to make a real difference involves companies developing alternative low-carbon business opportunities. Three broad Scope 3 net zero business models have emerged according to Wood Mackenzie. 

‘Big energy’ involves shrinking oil and gas production while expanding into renewables. ‘Carbon as a service’ means an aggressive expansion into carbon capture and storage (CCS) and carbon removal. Meanwhile, ‘Sustainable fuels’ requires a focus on low carbon fuels and the circular economy.

However, significant barriers lie in wait for those that attempt to pursue one or more of these strategies. An example of this are the recent poor returns from renewable energy investments as interest rates, material costs, and supply chain issues soared. The shareholder backlash has lent weight to calls for some companies to consider pivoting back towards their legacy fossil fuel business. Most recently, activist investor Bluebell Capital Partners called on BP to ditch its strategy to transform itself into a clean energy provider which it claimed is “destroying” shareholder value. 

Meanwhile, many low-carbon and sustainable fuel businesses are still in their infancy. CCS, carbon removal, e-fuels, and hydrogen will be heavily dependent, at least in the early stages of development, on government policy support.  

Alternatively, companies could consider purchasing high-quality carbon removal credits to abate their Scope 3 emissions. This could include nature-based projects such as afforestation and mangrove development, or technology-based removals including Direct Air Capture, biochar, or enhanced weathering. Nevertheless, there are concerns around the permanence of nature-based removals, while technology-based removal capacity has yet to reach the scale necessary to make a dent in Scope 3 emissions.  

Even despite those constraints, pressure is mounting on the Science-Based Targets initiative (SBTi) – a body that defines and promotes best practice in emissions reductions and net zero targets – to allow companies to use carbon credits help to meet their Scope 3 emission targets. 

It is tempting for oil and gas companies to point to government laws and regulations – fuel duties, indirect carbon taxes, and the like – close to the point of consumption, as already accounting for the externalities associated with end user Scope 3 emissions. These are, they might argue, not something that oil and gas producers can influence.  

But as Scope 3 emission reporting goes global, and banks extend that impact via their financing, the pressure to pivot to a low-carbon business and cut Scope 3 emissions is only likely to grow.