Emission Management for Commodity Firms

Executive Summary

Global warming and emissions are at the center of discussions over the world. The G20 group has set ambitious targets to limit global rise in temperature by the end of the century. Industries and organizations are under regulatory watch to reduce their GHG emissions and reach net zero by 2050 to meet the global targets. The energy and the commodity sector are one of the major contributors to emissions.  Commodity trades are now looking to cut emissions by reevaluating their strategy across pillars like product, people, processes, and technology.  This paper focusses on carbon emissions for commodity traders and its impact and mitigation strategies from an IT perspective

Carbon emission management across commodity traders is in its early days. One of the biggest issues for traders is identifying and calculating their organization footprint. Emissions across processes and transport using different ladders of the value and supply chain are difficult to correctly calculate. This paper talks about the various carbon management strategies used by commodity traders. We touch upon Carbon calculators being increasingly developed and used across the spectrum to correctly calculate emissions. Carbon abatement through new efficient processes, supporting low carbon alternatives and substitute metals and carbon offset project development are important ways commodity traders are planning to reduce their carbon emissions.

The paper talks about the major challenges and risks faced by commodity traders and its possible IT solutions. The lack of governance and basic regulatory oversight have been a hinderance to commodity traders having standard emission control practices. The absence of standard technology practices hand lack of green fuel have resulted in commodity traders not shifting to low emission technologies in a mass way. Transition risk is also a risk of shifting to low carbon alternatives which might not yield the desired profits is a big risk the commodity trading industry is facing which is also acting as a barrier to shift to low carbon alternatives.

The paper also discusses about the various IT solutions which can help the commodity traders in navigating their strategy towards a low carbon emission future. we discuss solutions such as integrated business process registries integrating the carbon value chain smart algorithms and data management solutions.

The impact of net zero by 2050 is going to disrupt multiple industries at multiple levels, commodity trading being one of the most impacted industries. An early foray into the possible solutions for lowering carbon emissions would enable the commodity traders to have their strategies and place to achieve net zero by 2050 with minimal or no impact to profits and a smooth transition to low carbon substitutes. Managing this transition is going to be critical and will

Background

More and more countries, global leaders and organizations are now pledging to clean the environment by reducing their green-house gas (GHG) emissions to every possible extent. In the recently ended COP27, the G20 leadership has also reaffirmed the pledges to limit global warming to 1.5 degrees Celsius above pre-industrial levels. Hence it is quite evident that the companies are now going to focus on reducing their carbon emissions from the regular business operations in the upcoming years.

Commodity traders are one of the most impacted entities as carbon emissions are a byproduct of their core strategic and operational businesses. The commodity traders with their core activities of extraction, smelting, refining, drilling, logistics, shipments typically release a large amount of both the scope 1,2 and scope 3 GHG emissions. Even for them the net Zero or target 2050 is a strategic shift to an operating model with net zero carbon emissions. Shifting to alternative fuels or low carbon substitutes is a long-term target, hence the commodity traders must make gradual progress of shifting their business models with lower carbon emissions. In parallel, they should also focus on enhancing their infrastructure by monitoring and tracking their carbon emissions at each transaction, business units and region level and at the same time keep close comparison with the actual target set by themselves as well as the regulator bodies. Carbon trading firms need to relook the entire net zero holistically, covering the product strategy, process, people, and technology

Net Zero-Impact on commodity trading

Commodity Trading is an industry profoundly impacted by the transitions to low carbon economy. However, by impact it is also an industry crucial to meeting the goals of 2050. Energy (Oil & Gas), Metals etc. are major contributors to the GHG emissions as a considerable number of emissions are from the extraction, transformation, and the transport for the same. Most major commodity traders have setup independent carbon desks to trade in carbon related offsets to mitigate or even use carbon offsets as arbitrage. The motivation factor for carbon credits and ESG in general is driven by 2 major factors, viz, Pledge to Net Neutrality and Shareholders’ pressure to have a futuristic plan for mitigating carbon emissions.

Commodity firms and industries now have also started investing heavily into cleaner energy alternatives like renewable energy. It’s evident that over past 15 years, there is a significant investment on various sectors of low carbon emission products by the major commodity firms.

Commodity traders are taking initiatives to re-structure their internal operations to achieve the net-zero objectives. Multiple initiatives around the operations and IT landscape and expected to be implemented/ executed with priority considering the intermediate to long-term targeted timeline.

So overall, the commodity trading firms are already focusing and need to emphasize their focus in multiple initiatives to track and reduce their net carbon emission to be aligned with the targeted timeline of global net-zero emission.

Carbon Management

Commodity trading firms are one of the focal points in the industry leading the shift to reduce emissions. With processes ranging from extraction to transformation and transport the impact along the value chain is high and consistent. Carbon management for commodity traders hence becomes critical to their future core function. Firms have already started taking steps in the direction to reduce their carbon exposure. The impact is across the core pillars for the organization namely product, people, process, and technology affecting each in a major way.

Measuring and Managing Carbon Footprint: 

Before carbon traders can start to reduce their carbon emissions, they would be required to analyze their business model internally calculate their existing carbon emissions called carbon accounting. Organizations would need to analyze their portfolios to determine their scope 1, 2 and 3 emissions. Organizations are also investing heavily in carbon calculators of their own to discover and identify carbon emissions along each of their value chains. Trafigura for example has created a carbon calculator which aggregates data across a range of business processes and supply chains and calculates the Carbon footprint. The calculator is used by the trading teams and the new carbon trading desk, to quantity and manage emissions from the Trafigura group supply chain

Abatement options

Organizations offer several carbon reduction initiatives for physical reduction of carbon emissions. Abatement is the substitution of a process with other that lowers the carbon emissions. Shifting to low carbon metals, cleaner fuel alternatives such as biofuels or electricity generated through solar, wind is what commodity firms are increasingly looking for as abatement options.  The below graph shows the potential for the various sectors to abatement to low carbon.

Shift to Low carbon products:

Shift to low carbon metals forms the core of the product strategy. Offering low carbon metals form a core part of the portfolio for majority of the commodity traders. Extraction, smelting, transformation, and transport are critical to commodity traders trading in metals. Low carbon alternatives such as low carbon aluminum, nickel, zinc is something that commodity traders around the world are offering as an alternative to the existing legacy high carbon emission products. Good persistent demand from customers looking to reduce their emission is also driving this shift to low carbon trading.

Efficient Logistics

Logistics being an integral part of the commodity industry. Scope 1 & 3 emissions form a major part of the emissions for commodity traders. Commodity traders are looking at optimizing their supply chains to reduce their logistical emissions. Shift to electric vehicles, e-Vessels for shipping are a major shift the industry is going through. The global maritime forum is a positive step in this direction.

Carbon Offset Project Development

A part of carbon management also deals the carbon offset project developers. Commodity firms are increasingly working with project developers by investing and guiding projects which generate carbon credits. Commodity traders are entering into forward offtake agreements with mature projects and assessing feasibility for upcoming projects Eg: Trafigura is supporting a Blue Carbon mangrove project named Delta Blue Carbon Project based out of Pakistan.

Pathway to net zero – initiatives from the big firms

A pathway to net zero is a roadmap by an organization to achieve the target of achieving net zero carbon emissions. With policies and regulations increasingly tightening to achieve the target of net zero emissions by 2050 various organizations have already laid out ambitious targets to reach net zero by 2050. Here we will look at the below strategies adopted by major commodity traders

Trafigura

Trafigura is a commodities trader trading in oil and petroleum products, metals and minerals and power and renewables. As one of the largest commodity traders and logistics providers in the world,

• Trafigura has set a target for reducing their GHG emissions by 30% by 2023 & targets to reduce the intensity of total shipping emissions by 25 percent by 2030 which covers 70% of their scope 3 emissions
• Has acquired entities like Nyrstar which supplies low carbon zinc and aluminium supporting the switch to low carbon metals
• It has also Invested in H2 Energy, a Swiss pioneer in green hydrogen production, storage, and distribution for re-fuelling stations and industrial customers.
• A blockchain solution is being initiated to dynamically trace and attribute the GHG emissions throughout the supply value chain to correctly identify and eliminate scope 3 emissions

Glencore

Glencore is one of the world’s largest globally diversified natural resources company. Glencore produces and markets a diverse range of metals and minerals – such as copper, cobalt, zinc, nickel, and ferroalloys.

Glencore has defined the below targets for its decarbonization pathway

• Reducing scope 1 and scope 2 emissions by developing a group wide Marginal Abatement cost curve (MACC) to capture existing and potential emission reduction across portfolios
• Allocating capital to prioritise transition low carbon metals. Construction of next generation of nickel mines in Canada
• Supporting uptake and integration of abatement an essential contributor to achieving low – or net zero carbon objectives. Glencore is investing in low emission technologies like CCUS* which will reduce emissions from coal and provide pathway for production of blue hydrogen *(Carbon Capture Utilization and Storage)
• Recycling various commodity products to improve efficiency in the circular economy. E.g.: Recycling Copper will use 80-90% lesser energy than mining and smelting the metal.

Gunvor

Gunvor is one of the world’s largest commodity traders. Gunvor sources source crude oil and refined oil products from more than 100 countries and various commodities which are highly carbon intensive. Carbon management hence is a critical function for Gunvor.

As a part of the sustainability effort Gunvor has outlined the following key aspects to its sustainability commitment

• Gunvor has committed to follow the IMO improvement in efficiency targets of 40% by 2030, as per Gunvor’s membership in the Sea Cargo Charter.
• 100% of owned ships and 75% of time charter shipping fleet will be “eco-vessels” by 2022, with an overall 100% before 2027.
• Gunvor has established a dedicated entity (Nyera) to formalize nonhydrocarbon investments like renewable power, alternative fuels, biofuels comprising a minimum of 10% of net equity that, which is expected to raise a commitment of at 0.5 billion (USD).

Challenges

Lack of Governance and Basic Regulations

Even after the multiple meet and convention of the global leaders, there are still no strong regulation exists globally or across all the big and developed countries. This is certainly not enforcing the industries or the organizations to comply with any standard rules or norms.

• In absence of such regulations across countries, there are lack of sufficient regulatory pressure to transition quickly to green maritime fuel
• Lack of regulation is becoming a hindrance of developing any carbon market in many countries.
• At the same time, there is no rulebook to enable the cross broader trading and hence there is no standard measurement of carbon pricing and carbon quality to offset against the emissions.

Absence of Technology and Matured Solution

As emission reduction is a relatively new focus area for organizations; the technology is mostly absent or under WIP. Technology or process to aid the transition to a low carbon model are underdeveloped or lacking. The below issues are common across commodity traders looking to shift to a low carbon operating model.

• Most of the green fuel technologies are not market ready. Also, globally there is no clear single choice when it comes to zero-emission fuels today.
• Along with the absence of finalization of alternative fuel for marine vessels, the infrastructure on alternative fuels is also broadly missing globally
• There is no technology evolved yet to reduce the emission on fuel efficient transports and transports or vessels with alternate fuels.
• In absence of integrated collaborative solutions, the intensive collaborations among the stakeholders of the commodity trading value chain are missing broadly
• The below graph shows the shift in the product mix with a definite shift towards renewables and wind/solar

Transition Risk

• Commodity trading industry stands on the duality of trying to maximize their profits with energy and metals being its core business. Shifting to low carbon alternatives which might not yield as much profits but are sustainable in the long run.
• Investors will be needed to be aware of the transition plans of most major markets and market participants around the world.
• In addition to these, the complex change in the regular operations and infrastructure will certainly add more complexity to the situation.
• From the traditional carbon heavy energy trading, there will be stranded assets with significant book values which will have degraded economic value because of the transition to low-carbon economy.

The IT Solutions

With net zero pledges by various industries, carbon management has become an irrefutable part of an organizations plan. With net-zero emission being increasingly important for end customers and for organizations alike, there is an inherent need to lower emissions and become carbon neutral in the years to come. The carbon neutrality will bring a lot of stakeholder and public confidence as global warming becomes increasingly relevant and comes to the center stage.

Organizations are paying a premium amount to get internal systems in check or develop new systems to calculate their carbon emissions correctly. Top dollar is being paid to internal and external organizations to correctly arrive at the exact carbon exposure from core and non-core activities. Use of big data and Machine learning is used to extrapolate the requirements over the next few decades to arrive at a measurable goal which can be sustainable with the current organization and operations.

Organizations will need the following to correctly assess and navigate this complex maze of carbon neutrality

Integrated Business Processes – Registry

• Introduce end-to-end integrated solutions to track the emissions across different processes and commodities
• Introduce the Carbon emission value at each transaction level
• Maintain the estimated carbon emission value and quantify/ calculate the emission value sourcing from various processes across all commodities including:
  • Extraction
  • Refining
  • Manufacturing
  • Warehousing
  • Distribution
  • Transportation
  • Recycling
  • Waste Products
  • Integrated view to visualize and track emissions at portfolio/desk level
  • The registry helps track desk level and overall emissions over multiple time series for better understanding of high emission portfolios
  • Customized thresholds for high emission operations/ products to limit breaching emission targets
  • Real time executive level view of the current, estimated, and projected emissions over time

Integrating Carbon Value Chain

• With operations spanning multiple products and modes of delivery, emissions also vary drastically as per the business 
• Blockchain, can potentially serve as a building block to categorize and track emissions across different operations and at a greater level of detail 
• Organization level blockchain implementation can help track and digitize emissions across operations and portfolios 
• Emissions on the various stages of the blockchain can be traced and tracked with greater level of detail 
• An ecosystem integrating external vendors on the same blockchain to track emissions outside of the parent organization can help trace scope 3 emissions better 
• An industry wide blockchain can have multiple use cases of better traceability of emissions and offset contracts 
• This can also serve as a base for buying and selling of offset contracts at lower costs. 

Smart Algos

• High level data collected at source, ML models can categorize and suggest efficient logistic alternatives for delivery
• Deliveries can be combined or netted with lower emission commodities or delivery locations to lower overall emissions
• Alternative routes, better operations across ports, storage units and last mile delivery can be achieved resulting in operational excellence thereby reducing overall emissions

Budgeting & Forecasting

• Introduction of forecasting tool with the help of AI solutions to predict the future forecasting of carbon footprint across all the business processes
• Following the top-down approach, building the budgeting solutions at organization, region, product, and desk level in alignment with local and global expectations and organization strategies
• Trade data fed to the ML algo can help train and build better models to accurately predict and help monitor overall trading strategies
• Targets can be set for individual product desk and monitored at an organization level to limit trading in high emission commodities
• Breaches in any desks can be highlighted and mitigation strategies can be applied on the same
• With enough data, traders can be provided with alternative low carbon commodities which can substituted as a abatement mechanism.

Data Management

• Build a firm-wide Data Strategy and Data Governance Process for carbon trading to build Data Accuracy, Data Granularity and Data Transparency
• With multiple asset classes and multiple modes of transport, a Master Data Management platform to be established to capture the correct data across different regions and business lines of the organization
• IoT enabled integration system can be built to extract the accurate data from various transactions to maintain the consistency in Data quality
• Blockchain as described previously can serve as an excellent base for data management

Carbon Tracking and Footprint Analysis Dashboards

• Dashboards serve an efficient way of tracking and monitoring desk level and organization level emissions levels and thresholds
• The carbon attribution can be shown globally in the hierarchy of Company, Master Desk, Desk, Region, and products. The attribution can compare the actual consumptions with the carbon allocation at each level of hierarchy.
• The comparison between the carbon allocation and actual consumptions can covers parameters like
  • YTD Consumptions
  • YTD Limit Allocations
  • Forward Months Forecast Consumption
  • Forward Months Limit Allocation
  • Total Forecasted Consumptions
  • Total Limit Allocation.
  • Scope for internal carbon offsetting within desks, regions and commodities is possible at this level
  • Set up the Internal Transfer Pricing of Carbon credit within the trading desks and track it as part of accounting PnL

Tool for Simulation and Optimization

Achieving net zero emissions is an eventual goal for commodity traders. However, the emissions are varied and spread across processes. The processes and the emissions also vary vastly in the emissions associated with each product. Hence, the traders can use some simulation tool to evaluate different strategies to achieve the net zero emissions.

• Simulation tools from which the traders can assess their strategies on carbon offsetting and simulate the results by testing across different product conditions and dataset.
• The simulation tools might also help in getting the outcome by altering various transactions from current processes including extractions, manufacturing, transportation etc.
• These tools will help the traders to measure and assess the marginal impact of each commodity or transactions and help further to optimize the organization strategies.

Conclusion 

The impact of achieving net zero by 2050 is going to disrupt various industries at varying in degrees. Commodity trading being a high emission business is going to be under severe stress and increase scrutiny. It's one of the industries that's going to be directly impacted by the ESG norms. The factors like Government policies, Technological change and ESG investments will be the key drivers for these changes. Organizations will further be under intense scrutiny from Regulators and Governments for the correctness and accuracy of the data.

For emissions such as scope 3 which are not a part of the core processes and originate from the upstream and downstream processes such as transport. Organizations will need to integrate emissions from such processes to be considered as scope 3 emissions. Registries will need to be incorporated to efficiently track emissions outside of the core systems.

Many of the existing leaders in commodity trading might have to change their existing business model dramatically to suit the changing needs of the business landscape. To make the business more efficient, the underlying IT systems and its architecture needs to be created in a robust and scalable manner so that it can support the future towards low carbon commodities business. However, since the entire low carbon/transition industry is still in a disruptive phase and yet to mature completely, flexibility is needed to cater to any unforeseen scenarios that may come up in the future. The accuracy, timeliness and the versatility of the data will be a key consideration. Organizations will now need to align their business and IT strategy and commit to it for the next few decades to have a clear roadmap for the transition to a low carbon business model.

About the Authors

Sathyanarayanan Palaniappan-

Sathya is a practice leader for Cognizant's Global Capital Markets and Risk & Compliance consulting practice. He has worked across geographies to provide advisory services to clients on digital transformation, process re-engineering and regulatory adherence. He is passionate about driving change and growth agenda for Banking and Financial Services clients.

Pramit Basu

With over 2 decades of experience under his belt, Pramit is a veteran in consulting. Having worked across the globe in various consulting assignments in the past. He has expertise in Capital markets and is a subject matter expert in Asset and Wealth Management

Sumit Adsule

With over a decade of experience, Sumit is a subject matter expert in the risk and the regulatory reporting space. He has worked across the compliance departments of major Banks and commodity traders. AI and sustainability are his key area of interest.