The proposed rule requires companies registered with the SEC to provide climate-related information in their registration statements and annual reports. These are the climate-related risks, which are likely to have a ‘material impact’ on its business, results of operations or financial condition. These risks turn out to be the amount of greenhouse gas emissions, as the way of measuring the exposure to such risks. Some of these measurements would have to be included in the company’s audited financial statements.
This is all as a result of the Paris Agreement of 2015 in which the target is altered every so often in accordance with the ‘science,’ underlying the development in policy and the targets for limiting greenhouse gases agreed by the. ‘Conference of the Parties’ each year. COP 26 in Glasgow last October agreed on the net zero target of carbon emissions by 2050. But this is only an Agreement, not a legally binding treaty. The Paris Agreement was allegedly structured in such a way as not to be classified as a treaty, so that President Obama would not have to seek the approval of Senate. That would be the case if it was in fact a treaty. Even as such, it is an Agreement more honored in the breach than the observance. The actions on China, India, Indonesia, Cambodia, Vietnam and Australia’s decision to export coal all demonstrate that. Of course, Russia’s attack on Ukraine and the dependence of Europe on Russian oil and gas, shows both that Russia does not have any intention of implementing COP 26. The geopolitical risks of dependence on Russian oil and gas and their search for other suppliers of oil and gas as well as reopening coal fired power stations shows that fine words in Glasgow have been abandoned in the face or economic and political realities.
None of this disturbs either the EPA or Chairman Gensler. Much of the content of the proposed Rule has been imported from the EPA, making the SEC appear to be an extension of the Environmental Protection Agency. The purpose of the Rule is to enable investors to assess the extent to which the registered companies are acting to achieve the net zero target for carbon emissions.
The measurement of GHG emissions falls into three categories: Scope 1: direct emissions from operations owned or controlled by the registered company; Scope 2: indirect emissions from the generation of purchased or acquired electricity, steam or heat or cooling that is consumed by operations owned or controlled by a registered company. The process involves recording the amount of energy used and then using the relevant conversion factors to calculate the GHG emissions. These may change over time, so companies have to keep up with new developments, which suggests that accuracy at any one time could be a problem.
Scope 3 is even more complicated and much more difficult to estimate. It refers to all the emissions arising from the upstream and downstream activities of a registered company’s value chain, covering the transport of all the goods and services a company needs, including the supply of raw materials, employee business travel, and transporting goods to clients and retail outlets. For downstream activities, a retail company would have to calculate their Scope 3 emissions, such as those arising from their customers’ mode of traveling to the grocery shop. This raises some interesting questions: how would they know? If the company did know that most of their customers traveled by car to get the weekly grocery, what is the company supposed to do about it? Do policy makers expect that companies should tell people how to come to the store? They would probably lose customers if they told them to get on their bikes.
Much more significant, however, than the application of Scope 3 to the extent outlined above is the requirement to include under Scope 1, Direct GHG from operations owned or controlled by the registered company. That would apply to many companies with operations in China, India and other Asian countries. The USA imports a wide range of manufactured goods from China, ranging from electrical goods, computers, nuclear reactors, clothing,, paper, stone, cement to toys from China. These owned or controlled companies would have to report GHG emissions under Scope 1, 2 and 3.
The reason for this lies in China’s energy production and distribution. According to the Global Energy Monitor, 15 countries commissioned new coal power in 2021, with more than half (56%) was in China, followed by India and Southeast Asian countries, including Vietnam and Cambodia. So far this year, China has granted at least 7.3 GW of new capacity permits this year and expects to add a further 120 GW to the 2021 level by 2025 and 150 GW by 2030. Investors in American companies would have to take GHG emissions from goods manufactured or imported from China into account. China will obviously continue to use coal-fired power plants for all its manufacturing. As a consequence, companies here would have to replace manufacturing in China with manufacturing in the USA. How would that be achieved without an uninterrupted energy supply which wind and solar cannot provide. China is clearly not going to take the lead or play any part in decarbonizing the world. So companies have a ‘choice’: either continue to supply those goods and services, China provides or go out of business, because without a continuous supply of energy, that cannot be done.
Yet Larry Fink’s 2022 letter to CEOs stresses the part companies are now expected to “play a role in decarbonizing the global economy. Few things will impact capital allocation decisions -and thereby the long -term value of your company-more than how effectively you navigate the global energy transition in the years ahead. It is two years since I wrote that climate risk is investment risk. And in that short period, we have seen a tectonic shift in the allocation of capital. Sustainable investments have now reached $4 trillion…and this is just the beginning.” That is with the help of his company, BlackRock, one of the largest mutual funds and its allocation of capital.
The problem is that decarbonizing the world is fraught with problems, of which the most severe is the lack of a continuous energy supply, required for so many aspects of modern life, ranging from public drinking water and waste water utilities to the manufacture of wind turbines, made out of steel; for example, using electric arc furnaces for recycling scrap metal requires 50 days of continuous electricity for the electric arc furnace. What is interesting is that it is companies, which are expected to make the transition to the fossil fuel free world. Governments and policy makers have done little to fund alternative sources of constant energy supply and reject nuclear power. The transition is only possible if storage of energy provided by wind and solar, when the wind does not blow or hurricanes and storms destroy the turbines or they cease to work or when the sun does not shine. People murmur “batteries”, but batteries on such a scale and requiring such a range of minerals are simply not available and there is no evidence that batteries to keep mega cities supplied with power are forthcoming. These concerns have not stopped Fink from establishing a large mutual fund in China in September, 2021. Are all those investments free of GHG?
Back to the proposed Rule. In effect, this will over time restrict available capital for industries, and many other companies, including banks, hospitals, and drinking water, domestic heating in extremely cold weather, which have to use fossil fuels for a reliable and continuous source of energy. The proposed Rule moves into unchartered territory in that it goes far beyond the prevention of fraud, fair markets and the protection of investors.