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Greenhouse Gas (GHG)

A Greenhouse Gas (GHG) is any gas in the atmosphere that absorbs and emits heat, contributing to the greenhouse effect that warms the Earth's surface. In a financial context, GHG emissions are a critical, quantifiable metric used to assess the climate-related risks and opportunities facing companies, industries, and investment portfolios.

  

While the greenhouse effect is a natural phenomenon, human activities—primarily the burning of fossil fuels—have drastically increased the concentration of GHGs in the atmosphere, leading to global climate change. For investors and businesses, GHG emissions are no longer just an environmental data point but a core financial liability and a key performance indicator. Governments are increasingly regulating these emissions through carbon pricing, taxes, and mandatory reporting, creating tangible costs for emitters and opportunities for innovators in low-carbon solutions. As a result, accounting for GHG emissions is now central to modern risk management and ESG Criteria.

To standardize reporting and comparison, different gases are often expressed in a single unit based on their global warming potential (GWP). The most important concepts are:

  • Carbon Dioxide (CO₂): The most prevalent GHG emitted by human activities, primarily from burning fossil fuels like coal, oil, and natural gas. It serves as the baseline for measuring other gases.
  • Methane (CH₄): A more potent GHG than CO₂, with a much higher heat-trapping capacity over a shorter period. It is primarily emitted from agriculture, waste decomposition, and natural gas operations.
  • Nitrous Oxide (N₂O): A long-lasting GHG emitted from agricultural and industrial activities, as well as the combustion of fossil fuels.
  • Carbon Dioxide Equivalent (CO₂e): This is the standard universal unit. It converts the impact of different GHGs into the equivalent amount of carbon dioxide. For example, since methane is more potent, one tonne of methane is equivalent to many tonnes of CO₂e. This unit is essential for Carbon Offsetting and is the currency of carbon markets.

Concrete Examples

  • Corporate Risk and ESG Analysis: An investment fund analyzes a utility company's annual sustainability report. It notes high and rising GHG emissions, indicating significant exposure to future carbon taxes and regulatory risk. This bearish outlook on the company's ability to transition may lead the fund to sell its bonds and shares.
  • Compliance Costs in Carbon Markets: Under the EU Emissions Trading System (EU ETS), an industrial manufacturer must surrender one carbon allowance for every tonne of CO₂e it emits. The cost of these allowances is a direct operational expense that impacts the company's bottom line, making access to capital for decarbonization a critical issue.
  • Achieving Carbon Neutrality: A technology firm calculates its annual GHG footprint across its operations (offices, data centers, travel). To fulfill its Corporate Social Responsibility (CSR) commitments, it purchases an equivalent volume of carbon credits from a verified renewable energy project, thereby offsetting its emissions.

For the most authoritative scientific assessments on greenhouse gases and their impact on climate change, the reports from the Intergovernmental Panel on Climate Change (IPCC) are the global standard.

Frequently Asked Questions

What is the European Union Emissions Trading System (EU ETS)?
The European Union Emissions Trading System (EU ETS) is the cornerstone of the EU's policy to combat climate change and its key tool for reducing industrial greenhouse gas (GHG) emissions cost-effectively. Launched in 2005, it operates on a “cap and trade” principle, covering over 10,000 heavy-energy-using installations in power generation, manufacturing, and aviation. The system's primary goal is to create a financial incentive for companies to lower their carbon footprint, making pollution a measurable cost.
How does the EU ETS encourage businesses to reduce emissions?
By putting a price on carbon, the EU ETS encourages businesses to invest in more efficient, low-carbon technologies. It directly impacts the operational costs of polluters, rewarding those who innovate and penalizing those who lag behind.
What is the “cap and trade” principle in the EU ETS?
The EU ETS operates on a “cap and trade” principle consisting of three main parts:
  • The Cap: The EU sets a total cap on greenhouse gas emissions from all participating installations, which is gradually lowered over time to meet climate targets.
  • Allowances (EUAs): Emissions under the cap are divided into tradable allowances called European Union Allowances (EUAs), where one EUA permits the emission of one tonne of CO₂. Many allowances are sold at auction by member states.
  • The Trade: Companies must surrender enough allowances to cover their emissions each year. If they emit less, they can sell surplus allowances; if more, they must buy additional allowances from others, creating a dynamic carbon market.
Can you provide a concrete example of how the EU ETS works?
Imagine two companies under the EU ETS:
  1. The Coal Plant: An older coal-fired power plant emits a large amount of CO₂, quickly uses up its allowances, and must buy more on the market, increasing costs and reducing profitability.
  2. The Gas Plant: A modern, efficient gas-fired power plant emits less than its allocation, resulting in surplus EUAs it can sell to the coal plant, generating additional revenue and rewarding cleaner technology investments.
This market mechanism makes clean energy more competitive and accelerates the shift away from fossil fuels.
Where can I find more information about EUAs and the EU ETS?
For more information on the specific asset, read our guide on European Union Allowances (EUAs). For official details, refer to the European Commission's EU ETS page.
Other Terms Fundamental Carbon-Market Concepts