Classification Systems for Setting Net-Zero Targets for Industries

Abstract

The structure of the Global Industry Classification Standard (GICS) system and how it is used in the OECM are described, as well as how the statistical data of the International Energy Agency (IEA) were merged with the GICS structure. The development of the pathways for the industry and service sectors, based on the GICS and IEA data, is explained, together with the parameters that are important for the financial industry. In this context, the definitions of Scope 1, 2, and 3 emissions newly developed for the OECM are explained, as well as how the systemic error of double counting in the original procedure can now be avoided.

Investment decisions, such as the decarbonization targets for the finance industry (see also Chap. 2), are highly complex processes. In November 2020, the European Central Bank published a guide on climate-related and environmental risks, which maps a detailed process for undertaking ‘climate stress tests’ for investment portfolios. To achieve the Paris Climate Agreement goals in the global finance industry, decarbonization targets and benchmarks for individual industry sectors are required. This opens up a whole new research area for energy modelling because although decarbonization pathways have been developed for countries, regions, and communities, few have been developed for industry sectors. The OneEarth Climate Model (OECM) is an integrated assessment model for climate and energy pathways that focuses on 1.5 °C scenarios (Teske et al., 2019) and has been further improved to meet this need. To develop energy scenarios for industry sectors classified under the Global Industry Classification Standard (GICS), the technological resolution of the OECM required significant improvement. Furthermore, all demand and supply calculations had to be broken down into industry sectors before the individual pathways could be developed.

1 Role of the Global Industry Classification Standard (GICS) in Achieving Net-Zero Targets

The GICS was developed by the American investment research firm Morgan Stanley Capital International (MSCI) and Standard & Poor’s (S & P), a finance data and credit rating company, in 1999. According to MSCI, the GICS was designed to define specific industry classifications for reporting, comparison, and investment transaction processes (MSCI, 2020). The GICS has 4 classification levels and includes 11 sectors, 24 industry groups, 69 industries, and 158 sub-industries. The 11 GICS sectors are energy, materials, industrials, consumer discretionary, consumer staples, health care, financials, information technology, communication services, utilities, and real estate (Table 4.1).

Table 4.1 GICS: 11 main industries

This section provides an overview of the 1.5 °C sectorial pathways and the associated GICS sectors. The individual end-use sectors are subdivided into four major sections:

• 1. Industry (Chap. 5)

• 2. Service (Chap. 6)

• 3. Buildings (Chap. 7)

• 4. Transport (Chap. 8)

The focus of each of these sections is documented in dedicated chapters (see above) that focus exclusively on current and future market developments and their energy-related aspects. The non-energy-related greenhouse gas (GHG) emissions are described in a separate section (Chaps. 11 and 14).

The primary energy sector, fossil-fuel-producing companies, and the secondary energy industries, energy-distributing utilities, make up their own two GICS groups.

1.1 OECM 1.5 °C Industry Pathways and the Associated GICS Sectors

Table 4.2 provides an overview of the OECM 1.5 °C industry pathways. The majority are in the materials sector (1510) and the related sub-sectors chemicals (1510 10), construction materials/cement (1510 20), aluminium (15104010), and steel (15104050). Textiles and leather, which are classified as consumer durables and apparel (2520) in the subgroup textiles (2520 3030), are included because textiles and leather production are part of the industry sector in the International Energy Agency (IEA) World Energy Balances. To maintain consistency in the data sources across all the sectors analysed and to integrate the supply side with the OECM, this sub-sector cannot always follow the GICS categorization.

Table 4.2 OECM 1.5 °C industry pathways and the associated GICS sectors

1.2 OECM 1.5 °C Service and Energy Pathways and the Associated GICS Sectors

The four service sectors analysed are distributed across four GICS sectors. Agriculture and food processing is part of consumer staples (30), forestry and wood products are part of the materials group (1510 50), the fisheries industry is only represented by its actual product (fish), and the fishing fleet is not part of the GICS classification (Table 4.3). Finally, water utilities are part of the wider utilities group (55). The OECM 1.5 °C pathways for the primary energy supply are all included in the energy group (10), whereas the secondary energy supply is part of the utilities group (55) (Table 4.4).

Table 4.3 1.5 °C OECM service pathways and the associated GICS sectors

Table 4.4 OECM 1.5 °C energy pathways and the associated GICS sectors

1.3 1.5 °C Pathways for Buildings and Transport and the Associated GICS Sectors

The OECM pathways for buildings are all included in GICS sector 60—real estate (Table 4.5). However, it is unclear to what extent the actual electricity demand, especially of residential buildings, can be considered as part of an economic activity and therefore as the responsibility of the real estate industry itself. Whereas the energy demand for climatization (heating and cooling) is directly related to the building envelope and architecture and is therefore the responsibility of the real estate industry, the electricity demand for appliances is not related and is the responsibility of private households.

Table 4.5 OECM 1.5 °C energy pathways and the associated GICS sectors

Finally, the transport sector is part of the industrials group (20) and is represented as a subgroup under transportation (20) (Table 4.6).

Table 4.6 OECM 1.5 °C energy pathways and the associated GICS sectors

2 Adaptation of Energy Statistical Databases to the GICS Industry System

The OECM uses the IEA World Energy Statistics and Balances (IEA, 2021b) as one of the main input sources for energy demand and supply data for the base year and the historical time series for model calibration, as described in Chap. 3. To develop energy scenarios that are based on the GICS classification, the IEA final energy demand sectors used for statistical data must be adapted to GICS sectors. This section provides an overview of the two different categorization systems and how they differ.

2.1 The Industry Sector

The IEA database documentation (IEA, 2020) provides detailed information about various statistical parameters. Table 4.7 shows the IEA industry sector and how it is broken down into four main sub-sectors:

• 1. Mining and quarrying

• 2. Construction

• 3. Machinery

• 4. Manufacturing

Table 4.7 IEA World Energy Balances—definition of the industry sector (IEA, 2021a; ISIC, 2008)

The manufacturing sector consists of 11 industries, among the largest of which are iron and steel, chemical and petrochemical industries, and non-metallic minerals, which includes the cement industry. The IEA (IEA DB, 2020) identifies the subgroups of all economic sectors based on the International Standard Industrial Classification of All Economic Activities (ISIC) of the United Nations (ISIC, 2008).

The iron and steel sector, for example, includes all activities listed under ISIC divisions 241 and 2431. The ISIC lists under Division 241 manufacture of basic iron and steel and under 2431 casting of iron and steel: This class includes the casting of iron and steel, i.e. the activities of iron and steel foundries. This class includes:

• Casting of semi-finished iron products

• Casting of grey iron castings

• Casting of spheroidal graphite iron castings

• Casting of malleable cast iron products

• Casting of semi-finished steel products

• Casting of steel castings

• Manufacture of tubes, pipes and hollow profiles, and tube or pipe fittings of cast iron

• Manufacture of seamless tubes and pipes of steel by centrifugal casting

• Manufacture of tube or pipe fittings of cast steel

However, the IEA statistics do not provide a further breakdown of the energy demand for the specific economic activities listed under the ISIC divisions but lump them together. In terms of iron and steel, only one value is provided, and no further details are available. To match the IEA sector with the GICS sectors, the industry and service sectors of the IEA have been grouped according to GICS classes. The iron and steel industry is part of the GICS industry sector 15 materials (Table 4.2), subclass 151,040 metals and mining, and the sub-industry 15104050 steel. This group includes iron ore, as identified in the documentation. However, the same group (15 materials) also lists the aluminium industry (15194010)—a separate IEA statistical sector. Although the industry sectors of the IEA and the GICS systems correspond to a large extent, the service sector has significant differences.

2.2 The Service Sector

The IEA statistics do not have a service sector category as such. Under other sectors, the energy demand is broken down into four subgroups: (1) residential, (2) commercial and public services, (3) agriculture and forestry, and (4) fisheries.

Detailed data for water utilities, for example, are not available, and are part of commercial and public services, as highlighted in Table 4.8. When sector-specific data are not available, the energy demand has been estimated from the energy intensities based on GDP ([MJ/$GDP] or commodities, such as energy demand per cubic meter of water withdrawn [MJ/billion m³ water]). Furthermore, the service sectors agriculture and food and forestry & wood products (Chap. 6) are partly from IEA’s other sectors and partly from the industry section. Therefore, the current and future energy demand for agriculture and forestry has been derived bottom-up from energy intensities and calibrated with statistical data from the IEA for the years 2005–2019.

Table 4.8 IEA World Energy Balances—definition of other sectors

2.3 The Buildings Sector

The 1.5 °C OECM pathway for buildings (Chap. 7) consists of three sub-sectors: residential and commercial buildings and construction. The IEA statistics for the buildings sector is comprised of ‘residential’ and ‘commercial and public services’, excluding water utilities. There are also economic activities, such as Div. 38 (‘waste collection, treatment and disposal activities; materials recovery’), that are outside the OECM scenario breakdown. Therefore, the buildings sector has been calculated separately with a bottom-up approach, from the floor space and energy intensities per square meter, to project the current and future energy demands. The energy data for construction, which is part of the industry group, are taken from the IEA statistics.

2.4 The Transport Sector

Statistical data for the transport sector in the IEA database best match the GICS classification ‘2030 Transportation’, and the development of the OECM 1.5 °C pathways for aviation, shipping, and road transport is based directly on the IEA statistics. Table 4.9 describes the IEA data series for transport.

Table 4.9 IEA World Energy Balances—definition of the transport sector

The reported differences between IEA and GICS categorization systems lead to some inconsistencies, and discrepancies between the available statistical energy data and the actual energy demands for specific economic activities are unavoidable. The advantage of the high technical resolution of the OECM is also a disadvantage because it requires a significant amount of data, which are sometimes unavailable. Therefore, the energy demand projections may vary from those in other sectorial analyses.

2.5 From Sectorial Energy Scenarios for Industry Sectors to Emissions

The finance industry requires sectorial energy scenarios for the industry and service sectors to set sector-specific decarbonization targets. Increasingly, investment decisions of international and national banks, insurance companies, and investor groups are driven by key performance indicators (KPIs) not only for profitability but also with regard to the embedded GHG emissions of a company. For asset managers, it has become increasingly important to have access to detailed information about GHG emissions, e.g. whether or not a steel manufacturer is on a decarbonization trajectory. The emissions must be further divided according to the responsibility for those emissions. This is done by calculating the so-called Scopes 1, 2, and 3.

3 Methodologies for Calculating Scopes 1, 2, and 3

3.1 Calculation of Scopes 1, 2, and 3

Reporting corporate GHG emissions is important, and the focus is no longer only on direct energy-related CO₂ emissions but includes other GHGs emitted by industries. These increasingly include the indirect emissions that occur in supply chains (Hertwich & Wood, 2018). The Greenhouse Gas Protocol, a global corporate GHG accounting and reporting standard (WRI & WBCSD, 2021), distinguishes between three ‘scopes’:

• Scope 1—Emissions are direct emissions from owned or controlled sources.

• Scope 2—Emissions are indirect emissions from the generation of purchased energy.

• Scope 3—Emissions are all indirect emissions (not included in Scope 2) that occur in the value chain of the reporting company, including both upstream and downstream emissions.

The United States Environmental Protection Agency (US EPA) defines Scope 3 emissions as ‘the result of activities from assets not owned or controlled by the reporting organization, but that the organization indirectly impacts in its value chain. They include upstream and downstream of the organization’s activities’ (EPA, 2021). According to the EPA, Scope 3 emissions include all sources of emissions not within an organization’s Scope 1 and 2 boundaries, and Scope 3 emissions of one organization are Scope 1 and 2 emissions of another organization. Scope 3 emissions, also referred to as ‘value chain emissions’, often represent the majority of an organization’s total GHG emissions (EPA, 2021).

Whereas the methodologies for calculating Scope 1 and Scope 2 emissions are undisputed, the method of calculating Scope 3 emissions is an area of ongoing discussion and development (Baker, 2020; Liebreich, 2021; Lombard Odier, 2021). The main issues discussed are data availability, reporting challenges, and the risk of double counting. MSCI, for example, avoids double counting by using a ‘deduplication multiplier of approximately 0.205’ (Baker, 2020). This implies that the allocation of emissions based on actual data is not possible. Accounting methodologies for Scope 3 emissions have been developed for entity-level accounting and reporting (WRI & WBCSD, 2013).

By contrast, the OECM model focuses on the development of 1.5 °C net-zero pathways for industry sectors classified under the GICS (MSCI, 2020), for countries or regions or at the global level. Emission-calculating methodologies for entity-level Scope 3 require bottom-up entity-level data to arrive at exact figures. Therefore, data availability and accounting systems for whole industry sectors on a regional or global level present significant challenges.

Therefore, Scope 3 calculation methodology must be simplified for country-, region-, and global-level calculations and to avoid double counting. In the Greenhouse Gas Protocol, Scope 3 emissions are categorized into 15 categories, shown in Table 4.10.

Table 4.10 Upstream and downstream Scope 3 emission categories (WRI & WBCSD, 2013; Baker, 2020)

To include all the upstream and downstream categories shown in Table 4.10 for an entire industry sector is not possible because, firstly, complete data are not available, for example, how many kilometres employees commute—and, secondly, it is impossible to avoid double counting, for example, when calculating Scope 3 for the car industry.

The OECM methodology is based on the Technical Guidance for Calculating Scope 3 Emissions of the World Resource Institute (WRI & WBCSD, 2013) but is simplified to reflect the higher levels of industry- and country-specific pathways. The OECM defines the three emission scopes as follows:

• Scope 1—All direct emissions from the activities of an organization or under its control, including fuel combustion on site (such as gas boilers), fleet vehicles, and air-conditioning leaks.

  Limitations of the OECM Scope 1 analysis: Only economic activities covered under the sector-specific GICS classification that are counted for the sector are included. All energy demands reported by the IEA Advanced World Energy Balances (IEA, 2021a) for the specific sector are included.

• Scope 2—Indirect emissions from electricity purchased and used by the organization. Emissions are created during the production of energy that is eventually used by the organization.

  Limitations of the OECM Scope 2 analysis: Because data availability is poor, the calculation of emissions focuses on the electricity demand and ‘own consumption’, e.g. that reported by the IEA, 2021b for power generation.

• Scope 3—GHG emissions caused by the analysed industry that are limited to sector-specific activities and/or products classified by the GICS.

  Limitations of the OECM Scope 3 analysis: Only sector-specific emissions are included. Traveling, commuting, and all other transport-related emissions are reported under transport. The lease of buildings is reported under buildings. All other financial activities, such as capital goods, are excluded because no data are available for the GICS industry sectors and would lead to double counting. The OECM is limited to energy-related CO₂ and energy-related methane (CH₄) emissions. All other GHG gases are calculated outside the OECM by Meinshausen and Dooley (2019).

The main difference between the OECM and the World Resources Institute (WRI) concept is that the interactions between industries and other services are kept separate. The OECM reports only emissions directly related to the economic activities classified by GICS. Furthermore, the industries are broken down into three categories: primary class, secondary class, and end-use activity class.

Table 4.11 shows a schematic representation of the OECM Scope 1, 2, and 3 calculation methods according to GICS class, which are used to avoid double counting. The sum of Scopes 1, 2, and 3 for each of the three categories is equal to the actual emissions. Example: The total annual global energy-related CO₂ emissions are 35 Gt in a given year.

• The sum of Scopes 1, 2, and 3 for the primary class is 35 GtCO₂.

• The sum of Scopes 1, 2, and 3 for the secondary class is 35 GtCO₂.

• The sum of Scopes 1, 2, and 3 for end-use activities is 35 GtCO₂.

Table 4.11 Schematic representation of OECM Scopes 1, 2, and 3 according to GICS classes, to avoid double counting

Double counting can be avoided by defining a primary class for the primary energy industry, a secondary class for the supply utilities, and an end-use class for all the economic activities that use the energy from the primary- and secondary-class companies. The separation of all emissions by the defined industry categories—such as GICS—also streamlines the accounting and reporting systems. The volume of data required is reduced, and reporting is considerably simplified under the OECM methodology.

For a specific industry sector to achieve the global targets of a 1.5 °C temperature increase and net-zero emissions by 2050 under the Paris Agreement requires that all its business activities are with other sectors that are also committed to a 1.5 °C and net-zero emission targets.

The results of the OECM Scope 3 analysis are documented in Chap. 13.