Paper 2
Executive Summary
Data on consumption emissions is lacking for much of the developing world, despite its relevance in avoiding disadvantageous sovereign carbon accounting for these countries
Consumption emissions are generally higher than production emissions with the lowest difference in the poorest countries
The measurement decision of using consumption versus production emissions has higher stakes for developed countries, particularly small ones like Singapore, Hong Kong, and Switzerland
While the ESG lens has become a common tool for managing risk in various financial assets, there is a growing interest among scholars and researchers in exploring how ESG risks manifest in sovereign credit markets. Given the increasing number of countries striving to transition to sustainable economies, it is expected that sovereign credit markets will attract more attention in the future. In theory, good ESG ratings are believed to correlate positively with political stability, a strong economy, and a steady flow of taxes that enables governments to repay their debt (Jeanneret, 2018). Countries that fail to diversify capital flows away from polluting sectors may be perceived as more risky in the long term due to increased environmental degradation, decreased competitiveness, and reduced appeal for investors (RobecoSAM, 2017). A more systematic incorporation of ESG factors into credit ratings could potentially influence borrowing costs for low-ESG countries, and motivate governments to accelerate their transition towards sustainability. Although the overall concept is clear, the details can be tricky. This paper examines only the Environmental aspect, with a focus on emissions, and excludes the Social and Governance perspectives.
Wealthy countries with the cleanest industries import raw materials, causing emissions downstream. Those raw materials often come from developing countries in which many polluting industries are concentrated. Developing countries have a critical need for financial support to transition to green practices and develop clean industries. Ironically, they would likely pay the highest premium if emissions were calculated based only on scope 1 or production emissions. To gain a comprehensive understanding of the emissions produced by a country’s industries and citizens, it is necessary to have data not only on produced emissions but also on consumed emissions. Unfortunately, this information is currently only available for 64 countries. Aggregating these emissions takes time, with the latest available data from the OECD dating back to 2018.
Available data indicates that consumption emissions per capita exceed production emissions in high, upper middle, and lower middle income countries. The gap between the two lines is smallest for lower middle income countries, revealing a negative correlation between income level and emissions per capita. A second graph demonstrates the effect of different denominators on emissions calculations. This graph illustrates that high income countries exhibit the lowest absolute level of emissions when GDP is used as the denominator in contrast to exhibiting the highest absolute level of emissions when population is used as the denominator. In both cases, consumption emissions are higher than production emissions.
The consumption vs. production emissions measurement decision has higher stakes for developed countries, particularly small ones like Singapore, Hong Kong, and Switzerland when using per capita as the denominator. While some upper and lower middle income countries would also fare worse, the ramifications of this measurement decision are particularly consequential for developed countries. Yet, some of them would also benefit from using consumption emissions, such as petroleum exporters Singapore, Greece and Malta.
This analysis asserts that incorporating consumption emissions per capita is the most appropriate approach for carbon accounting aligned with the Paris Agreement, as it accounts for emissions in supply chains attributable to wealthy nations. The decision to use consumption versus production emissions has significant implications for developed nations, particularly small ones like Singapore, Hong Kong, and Switzerland.More data on imported emissions is urgently required from the Middle East and Africa to implement a just and comprehensive carbon accounting mechanism. The latest comprehensive dataset (OECD) is from 2018, which highlights the overall need for better and faster data collection to represent an accurate picture of present day decisions and policies.