State of climate reporting: Five observations on energy and commodities trading

Observation 2: Traders are increasingly setting emissions intensity targets. This makes sense but they must be underpinned by clear and credible transition plans to avoid greenwashing accusations.  

Scope 1, 2 and 3 emissions are typically used to report on absolute emissions, reflecting the total amount of greenhouse gases (GHGs) emitted into the atmosphere by an organisation over a specific period. Traders, however, are increasingly also disclosing emissions intensity metrics, which reflect the amount of GHGs emitted for a given unit, such as grams of CO2 equivalent per megajoule or per tonne.  

In many ways, intensity metrics are a better measure than absolute emissions for trading. Absolute emissions are highly sensitive to volume fluctuations which means that, depending on the boundaries used, they tend to be directly linked to the size of a trading book and can misrepresent the climate impact of trading. For example, an oil trading organisation could be penalised for increasing their participation in a high-volume market such as natural gas even if it has lower emissions per unit than other fossil fuels. Conversely, the same trader could meet absolute emissions targets simply by cutting down the traded volume in an unprofitable book without actually reducing their real-world carbon impact. 

If used correctly, intensity metrics can be valuable tools to track progress against climate goals. They can be used to incentivise traders to trade lower carbon products by rewarding them for reducing their average emissions per unit of energy or mass traded. This also aligns with requirements from counterparts who may be interested in understanding the carbon intensity of purchased products. Indeed, green premiums are starting to develop in some commodity markets such as aluminium, where lower carbon intensity products can command a higher price. This will be strengthened by growing carbon taxation policies, such as the EU’s Carbon Border Adjustment Mechanism.  

However, intensity metrics should not replace absolute emissions reporting and any intensity-based targets must be clearly linked back to broader decarbonisation goals. To avoid accusations of greenwashing, traders must be able to demonstrate to investors how they will use intensity targets to drive down real-world emissions over the short, medium, and long-term by steering capital flows to lower carbon products.  

Doing this well is not easy, and it needs to be underpinned by accurate and meaningful data to avoid reliance on industry average emission factors which may not reflect the actual emissions of specific products or sources.

Observation 3: Climate risk reporting remains a formality. Banks and investors will require traders to do more.  

Traders are increasingly including disclosures in their annual reports to align with climate risk regulatory frameworks such as TCFD (and now, ISSB). Designed to improve the transparency and accountability of climate reporting, these frameworks require companies to disclose how climate change affects their financial performance, strategy, governance, and risk management.  

As part of our benchmarking, Baringa assessed the maturity of climate risk reporting in the industry against best-practice disclosure. We reviewed the climate disclosures of a variety of traders and assessed to what extent they met the recommendations for each of the TCFD/ ISSB pillars1: 

The result of our benchmarking shows that the trading industry still reports on climate risk at a high-level and generally does not have the level of detail required to meet the growing expectations of investors and the financing community. Our benchmarking also showed that, for integrated companies, the trading arm is generally not as compliant to ISSB and TCFD standards as other parts of the same entity. It is more complex to apply climate frameworks to a trading business and, as a result, integrated firms often omit information on their trading activities. 

Traders perform the least well against the Strategy pillar. This reflects the difficulty of the recommendations, such as the requirement to use scenario analysis to identify risks and assess strategic resilience, which is a challenging task (see observation 4). However, traders can enhance their disclosures without having to invest in complex scenario modelling. As a starting point, they can simply focus on analysing the impact of climate scenarios on key climate risks, such as physical risks for their assets, before building this out into more refined scenario modelling. 

The introduction of ISSB, as well as growing pressure from banks, will drive increased compliance across the market. Baringa is expecting to see a significant increase in the breadth of climate reporting from trading firms from 2024 and onwards. 

Observation 4: Traders must learn from financial services to incorporate climate scenario analysis into existing risk management practices. 

Managing risk is at the core of commodities and energy trading but very few traders directly consider the impacts of climate change as part of their trading risk functions. Incorporating climate scenario analysis into existing risk management practices is not only needed to align with frameworks like TCFD and ISSB but done correctly, it can also help traders better understand and manage the potential impacts of climate change on their operations. 

Climate scenario analysis, which is required under ISSB, can be invaluable tools for traders to stress test the potential financial impacts of climate scenarios on their portfolios. However, most traders still treat scenario analysis as a standalone sustainability requirement rather than incorporating it into existing risk practices. 

Part of the challenge is that climate scenario analysis requires a strategic and long-term perspective that may not align with the short-term and profit-oriented goals of trading organisations. Furthermore, traditional scenarios do not have the level of granularity, which is required to be relevant, consistent, comparable, and transparent in a commodities trading context, considering the specific characteristics, drivers, and uncertainties of the market. 

To tackle these challenges, traders must expand existing scenarios, considering specific characteristics, drivers, and uncertainties, and use them to further stress test their portfolio against specific risks, rather than their overall strategy or business model.  

For example, scenario analysis can be used in conjunction with traditional methods such as VaR to enhance market risk management. While traders will continue to use VaR to measure the baseline market risk of their portfolio based on historical data and a given confidence level, scenario analysis can be used to test how their portfolio would perform under various climate scenarios that may deviate from the historical data or assumptions.  

Another good example is credit risk. Climate change can significantly increase the risk of counterparts defaulting on their obligations, through physical damage to their assets and operations, or increased exposure to regulatory and legal risks. Traders should look to incorporate climate risk metrics into existing credit risk tools and processes, such as internal credit ratings. This is particularly relevant where traders may have longer-term exposure to counterparts, such as in markets like LNG where long-term contracts are common. 

Observation 5: Climate reporting is aligning with financial reporting.  

Climate reporting is no longer a distant task owned by a sustainability function. Under pressure from banks and regulators, traders are increasingly aligning their climate reporting to their financial reporting, with ownership coming under the CFO.