by Tajinder Dhillon.
The 2021 United Nations Climate Change Conference (COP26) is scheduled to take place from Oct. 31 to Nov. 12 in Glasgow, Scotland. Therefore, we take a closer look at carbon emission levels within the United Kingdom.
For this analysis, we look at Refinitiv ESG data for the current constituents of the FTSE 350 index (as of Sep. 30), which comprises the largest U.K. publicly listed companies by market capitalization and is home to many of the largest commodity companies globally.
Using Refinitiv ESG data, we can extract the total Carbon Dioxide Equivalent Emissions (will be referred to as CO2) as measured in metric tons for each company since 2010. The CO2 data field includes both scope 1 (direct) and scope 2 (indirect) emissions while excluding scope 3.
In 2020, 256 constituents of the FTSE 350 reported CO2 emissions data, which results in a 72.9% coverage ratio. This ratio has dramatically improved since 2010 where it stood at 42.5%. Over the last decade, we have seen increased adoption of companies proactively reporting emissions data.
Exhibit 1 highlights aggregated CO2 levels at both a sector and index level for the FTSE 350 index, using a portfolio share-weighted methodology.
Exhibit 1: FTSE 350 CO2 Equivalent Emissions
On an absolute basis, it appears that CO2 levels have declined over the last decade for the overall index, most notably since 2013. In 2020, aggregated CO2 was 311.7 million tons compared to 363.0 million tons in 2010. This equates to a 14.1% reduction over the last decade, or 1.5% on an annualized basis.
At a sector level, Materials had the largest contribution to CO2 levels in 2020 (42.5% of total emissions), followed by Energy (39.1%). More concerning is that the Materials sector is one of the few sectors in the index that have seen a rise in CO2 levels, increasing 38.8% over the last decade. Conversely, the Energy sector has seen a 23.9% decline in CO2 levels over the same period.
The Materials sector is home to many of the largest mining companies globally that focus on the extraction and production of steel, aluminum, coal, copper, zinc, among others, many of which are carbon-intensive in nature.
While absolute CO2 levels are important, it also makes sense to compare this metric to the annual revenues a company generates, to provide an apples-to-apples comparison. CO2 intensity is defined as CO2/Revenue ($ million), which is conveniently available in Refinitiv Eikon Workspace as a pre-calculated data field.
A lower carbon intensity ratio is desirable as this results in companies either a) lowering absolute CO2 levels or b) maintaining CO2 levels but increasing revenue over time, yielding greater efficiency in CO2 emissions per dollar in revenue.
In 2020, total CO2 levels were 311.7 million tons while total revenue in USD was $1.8 trillion. Dividing CO2 by revenue results in a CO2 intensity ratio of 171.7. We only included companies that had both CO2 and revenue data in the aggregate calculation for each year.
Exhibit 2 highlights the FTSE 350 CO2 intensity ratio over the last decade.
Exhibit 2: FTSE 350 CO2 Intensity Ratio
The CO2 intensity ratio has steadily declined from 2015-2019 (201.9 –> 150.3). However, the ratio increased to 171.2 in 2020. We believe this ratio has artificially increased due to COVID-19, where companies suffered dramatic declines in revenue.
Looking at the data closer, CO2 emissions declined from 364.2 million tons in 2019 to 309.8 million tons in 2020, a 14.9% decline. However, total revenues over this same period declined from $2.4 trillion to $1.8 trillion, resulting in a 25.6% decline. Therefore, the CO2 Intensity ratio artificially increased in 2020 due to simple math (a smaller denominator). If we used a pre-pandemic 5-year average revenue figure of $2.1 trillion, the 2020 CO2 Intensity ratio would decline to 144.9.
At a sector level, Materials, Utilities, and Energy have the highest CO2 intensity ratios. Materials had a 2020 CO2 Intensity ratio of 434.2, a 26.0% increase from 2010. The Utilities sector has a CO2 intensity ratio of 380.4 while Energy has a ratio of 348.5, increasing 45.8% from 2010.
We have seen that Materials and Energy are among the top sectors from both an absolute CO2 emissions and CO2 intensity perspective. Given the strong demand for ESG investing, we look at index composition to determine which indices have strong exposure to carbon intensive sectors.
While the FTSE 350 appears to be doing a good job in reducing CO2 emissions and intensity on an aggregate basis, it does have a relatively large weight to both the Materials and Energy sector.
The Materials sector has an 11.5% weight within the index, making it the fourth-largest sector by market cap. Energy also has a large weight of 8.6%.
When comparing to the FTSE Russell 1000 Index, the Materials sector has only a 2.3% weighting, making it the smallest sector, followed by a 2.6% weight for the Energy sector. The FTSE Europe ex U.K. Index also has smaller exposures to the two sectors relative to the FTSE 350.
We also include index composition weights for other energy intensive sectors in Exhibit 3, including S&P/TSX, Oslo All Share, OMX Helsinki, S&P/ASX 300, and Brazil Bovespa, which all have a large weight in either the Energy or Materials sector.
Exhibit 3: Index Composition Weights
Stay tuned for part 2 of this analysis which zooms into CO2 emissions and intensity ratios at a constituent level, while also looking at whether lower carbon lead to greater financial performance.
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