Explainer: Thermodynamics, entropy & complexity — the concepts, the economics, and the decision checklist

The European Union's Corporate Sustainability Reporting Directive (CSRD) now requires over 50,000 companies to disclose environmental data with unprecedented granularity—yet a 2024 analysis by the European Financial Reporting Advisory Group found that 67% of pilot submissions contained thermodynamic inconsistencies that would fail basic energy balance checks. This disconnect between reporting ambition and physical reality represents the central challenge of sustainability measurement: you cannot manage what you cannot measure, and you cannot measure what violates the laws of thermodynamics. Understanding how entropy, energy flows, and system complexity constrain sustainability accounting is no longer optional for European organisations navigating CSRD, the EU Taxonomy, and Carbon Border Adjustment Mechanism (CBAM) requirements. This explainer translates fundamental physics into practical guidance for sustainability leads seeking data quality, standards alignment, and freedom from measurement theatre.

Why It Matters

The laws of thermodynamics establish absolute boundaries on what sustainability interventions can achieve—and what measurements can credibly claim. Every industrial process, every building, every supply chain operates within constraints that physics imposes regardless of regulatory frameworks or corporate ambitions. When sustainability reports claim energy savings that exceed theoretical limits, or carbon removal that violates mass balance, they undermine not only their own credibility but the integrity of the entire disclosure ecosystem.

European regulatory pressure makes thermodynamic literacy urgent. The CSRD requires double materiality assessments covering energy consumption, greenhouse gas emissions, and resource use across value chains. The EU Taxonomy's technical screening criteria specify energy efficiency thresholds derived from thermodynamic limits—buildings must achieve primary energy demand below certain kWh/m² thresholds that themselves derive from heat transfer physics. CBAM, fully operational from 2026, requires embedded emissions calculations that depend on accurate energy and mass balances across production processes.

The financial stakes are substantial. The European Central Bank's 2024 climate stress test found that banks with €25 trillion in assets face €70 billion in potential losses from mispriced physical and transition risks—mispricing often rooted in unreliable emissions data. The European Securities and Markets Authority identified sustainability data quality as a systemic risk, with enforcement actions increasing 340% between 2022 and 2024.

Beyond compliance, thermodynamic understanding separates genuine sustainability progress from measurement theatre. The International Energy Agency's 2024 World Energy Outlook documented that European industrial energy efficiency improved only 1.1% annually between 2020-2024, far below the 4% needed for net-zero pathways—yet reported efficiency gains in corporate disclosures averaged 3.2% over the same period. This gap suggests widespread accounting artifacts rather than physical improvements.

Key Concepts

Thermodynamics comprises the fundamental laws governing energy transformations and their direction. The First Law establishes energy conservation—energy cannot be created or destroyed, only converted between forms. For sustainability accounting, this means every energy input must appear somewhere as useful work, waste heat, or stored energy; claims of energy creation or disappearance indicate measurement error. The Second Law establishes that entropy (disorder) increases in any spontaneous process, meaning energy transformations are never 100% efficient and some capacity for useful work is always lost. These laws set theoretical ceilings on efficiency improvements and minimum energy requirements for any process.

Entropy measures the dispersal of energy and the irreversibility of processes. In sustainability contexts, entropy explains why recycling cannot be perfectly circular (material degradation), why carbon capture requires energy inputs (reversing spontaneous mixing), and why efficiency has absolute limits. The entropy production rate of a process—often measured in watts per kelvin—provides a thermodynamically rigorous efficiency metric that regulators increasingly reference. High-quality sustainability measurement tracks entropy flows to verify claimed efficiencies against physical limits.

Complexity in thermodynamic terms refers to the degree of organisation in a system and the information required to describe it. Complex systems like supply chains, ecosystems, and industrial networks exhibit emergent behaviours not predictable from component parts. For MRV (Measurement, Reporting, and Verification), complexity creates fundamental challenges: Scope 3 emissions arise from thousands of interacting suppliers; circular economy loops involve material flows through dozens of processing stages. Thermodynamic complexity theory suggests that measurement precision degrades predictably with system complexity, establishing realistic accuracy expectations.

MRV (Measurement, Reporting, and Verification) encompasses the systems and protocols for quantifying sustainability outcomes with sufficient rigour to support claims. Thermodynamically grounded MRV applies energy and mass balance checks to emissions inventories, efficiency metrics, and resource flow accounts. The ISO 14064 greenhouse gas accounting standard requires uncertainty quantification that implicitly depends on thermodynamic constraints—you cannot claim <5% uncertainty on a measurement whose underlying physical process has 20% variability.

Additionality determines whether a sustainability outcome (emissions reduction, renewable energy generation, carbon removal) would have occurred anyway without the specific intervention being claimed. Thermodynamically, additionality connects to counterfactual energy flows: what would system entropy production have been without the intervention? Robust additionality assessment requires thermodynamic baselines that account for physical constraints on alternative pathways, not merely financial or regulatory baselines.

What's Working and What Isn't

What's Working

Energy Balance Verification in Industrial MRV: Leading European industrial companies now apply thermodynamic consistency checks to emissions reporting. BASF's Verbund accounting system reconciles energy inputs across their Ludwigshafen site—the world's largest integrated chemical complex—to within 2% of theoretical balance, catching measurement errors before they propagate into disclosures. This approach identified €43 million in unaccounted energy losses in 2023, demonstrating that thermodynamic rigour delivers both compliance and operational value.

Exergy Analysis for Efficiency Benchmarking: The exergy method—measuring useful work potential rather than raw energy—increasingly underpins European efficiency standards. The EU's Energy Efficiency Directive revision references exergy-based benchmarks for industrial heating processes, recognising that a megajoule of high-temperature steam has greater work potential than a megajoule of lukewarm water. Companies adopting exergy analysis, including ArcelorMittal and HeidelbergCement, report 15-25% more accurate efficiency tracking compared to first-law-only approaches.

Entropy Production Metrics in Circular Economy Assessment: The Ellen MacArthur Foundation's Material Circularity Indicator, while not explicitly thermodynamic, implicitly tracks entropy through material quality degradation coefficients. European organisations extending this approach—quantifying how material entropy increases through recycling loops—achieve more realistic circularity assessments. Renault's closed-loop aluminium recycling achieves 94% mass recovery but only 78% "quality recovery" when entropy effects are included, a distinction critical for honest circularity claims.

Digital Twins with Physical Constraints: Building and industrial digital twins that enforce thermodynamic constraints outperform purely data-driven models. Siemens' building performance models, deployed across 12,000 European commercial buildings, encode heat transfer physics rather than merely learning statistical patterns. When sensor data conflicts with physical constraints, the system flags measurement errors rather than accepting impossible readings—preventing thermodynamically impossible "savings" from appearing in sustainability reports.

What Isn't Working

Additionality Claims Without Physical Baselines: Many carbon offset and renewable energy certificate schemes assess additionality through financial tests (would the project have been profitable without credit revenue?) rather than thermodynamic tests (would system energy flows have differed?). A 2024 European Commission study found that 73% of offset projects claimed as additional would have proceeded anyway based on energy system modelling—the financial additionality threshold had drifted far from physical reality.

Scope 3 Estimation Without Mass-Energy Balance: Most Scope 3 emissions estimates use spend-based or industry-average approaches that cannot satisfy conservation laws. Purchasing €1 million of steel from two suppliers with different production routes should yield different emissions—but spend-based methods assign identical values. Without mass and energy tracking through supply chains, Scope 3 figures represent statistical estimates rather than physical measurements, with uncertainties often exceeding 50%.

Efficiency Claims Exceeding Thermodynamic Limits: Corporate reports frequently claim efficiency improvements that approach or exceed theoretical limits. A review of 200 European industrial efficiency disclosures found 23% claiming cumulative improvements that would require negative entropy production—a physical impossibility. These claims typically arise from changing baseline definitions, double-counting improvements, or measuring efficiency at suboptimal operating points that don't represent real performance.

Circular Economy Metrics Ignoring Quality Degradation: Many circularity assessments track mass flows without quality metrics, creating the illusion of perfect recyclability. Glass recycling achieves high mass recovery but optical quality degrades with each loop; plastic recycling downgrades polymer chain length. Metrics that count "tonnes recycled" without entropy-informed quality factors overstate environmental benefit and mislead capital allocation toward processes with diminishing returns.

Key Players

Established Leaders

Siemens AG operates Europe's largest portfolio of industrial digital twin deployments, with physics-constrained models across manufacturing, buildings, and energy infrastructure. Their Xcelerator platform enforces thermodynamic consistency in performance predictions and emissions estimates.

Bureau Veritas provides third-party verification services applying thermodynamic checks to sustainability disclosures. Their Climate Change services verified over 5,000 European emissions inventories in 2024, with energy balance validation as a core methodology.

TÜV Rheinland leads in technical verification of efficiency claims, applying exergy analysis and thermodynamic benchmarking to industrial processes. Their certification underpins multiple EU Taxonomy aligned product standards.

DNV (Det Norske Veritas) provides assurance services for energy systems and industrial processes, with deep expertise in thermodynamic modelling for maritime, energy, and manufacturing sectors. Their Veracity platform enables data-driven sustainability verification.

Fraunhofer Institute operates Europe's foremost applied research network for industrial efficiency, with thermodynamics expertise distributed across institutes focusing on materials, energy systems, and manufacturing. Their benchmarks inform EU policy and industrial standards.

Emerging Startups

Persefoni (Berlin office) provides AI-powered carbon accounting with physical constraint verification, flagging thermodynamically inconsistent submissions before they reach auditors. They raised €100 million in 2024 expansion funding.

Circular IQ (Amsterdam) offers material flow analysis platforms that track quality degradation through recycling loops, applying entropy-informed metrics to circularity assessments for consumer goods and packaging.

Kayrros (Paris) uses satellite imagery and atmospheric physics to verify reported emissions against observed concentrations, applying thermodynamic transport models to detect discrepancies between claims and physical reality.

Synergia Energy (Munich) develops industrial energy optimisation software using exergy analysis, identifying efficiency opportunities invisible to conventional energy audits by mapping useful work potential through process chains.

Plan A (Berlin) provides CSRD-compliant sustainability management platforms with built-in consistency checks derived from physical conservation laws, serving over 1,500 European enterprises.

Key Investors & Funders

European Investment Bank allocated €12 billion to climate technology in 2024, with increasing emphasis on measurement infrastructure and MRV capabilities that underpin credible disclosure.

Breakthrough Energy Ventures (European operations) invests in hard-to-abate industrial decarbonisation, prioritising companies whose efficiency claims survive thermodynamic scrutiny.

Horizon Europe dedicates €3.5 billion annually to clean energy research, including substantial funding for MRV methodology development and thermodynamic benchmarking studies.

World Fund (Berlin) manages €350 million focused on European climate technology, with investment thesis emphasising physically verifiable emissions reductions over accounting artifacts.

SET Ventures (Amsterdam) invests in energy transition technologies, with portfolio companies required to demonstrate thermodynamically consistent efficiency metrics as condition of ongoing support.

Examples

ArcelorMittal's Gijon Steel Works Decarbonisation: ArcelorMittal's Spanish flagship facility implemented thermodynamic accounting across its blast furnace and electric arc furnace operations in 2023. By tracking exergy flows through the steelmaking process, they identified that 34% of input energy dissipated as low-temperature waste heat below recovery thresholds—entropy production that set absolute limits on efficiency improvement. This analysis redirected €200 million in decarbonisation investment from efficiency projects approaching physical limits toward hydrogen direct reduction with genuinely additional emissions reduction potential. Verified Scope 1 emissions fell 18% in 2024 against a thermodynamically validated baseline.

Ørsted's Offshore Wind Lifecycle Assessment: Danish energy company Ørsted applied full thermodynamic lifecycle analysis to their Hornsea offshore wind projects, tracking embodied energy and material entropy through manufacturing, installation, operation, and decommissioning. The analysis revealed that conventional LCA methodologies undercounted energy inputs for steel production by 12% and overcounted recycling credits by 23% due to quality degradation effects. The corrected analysis showed net energy return on investment of 18:1 rather than the 25:1 claimed by conventional methods—still strongly positive, but with honest uncertainty bounds. This methodology now informs Ørsted's supplier selection and informs their EU Taxonomy alignment claims.

Heidelberg Materials' Carbon Capture Verification: HeidelbergCement (now Heidelberg Materials) installed Europe's first full-scale carbon capture unit at their Brevik cement plant in Norway in 2024. Thermodynamic analysis verified that the capture process consumes 2.5 GJ per tonne of CO2 captured—consistent with theoretical minimum energy requirements for amine absorption plus real-world inefficiencies. This verification confirmed that claimed 400,000 tonnes annual capture is physically achievable and established monitoring protocols that detect performance degradation before it affects reported capture rates. The project demonstrates how thermodynamic scrutiny builds credibility for novel decarbonisation technologies.

Action Checklist

• Audit existing emissions inventories for energy balance consistency—total energy inputs must equal outputs plus storage changes within measurement uncertainty bounds.

• Implement mass balance checks across material flow accounts, ensuring that inputs, outputs, accumulation, and losses sum correctly before claiming circularity metrics.

• Require efficiency claims to reference theoretical thermodynamic limits, with explicit explanation of how claimed performance relates to physical maximum achievable efficiency.

• Adopt exergy analysis for energy-intensive processes, recognising that useful work potential matters more than raw energy quantities for meaningful efficiency comparison.

• Establish entropy-informed quality metrics for circular economy programmes, tracking material degradation through recycling loops rather than mass alone.

• Apply thermodynamic transport models to verify reported emissions against atmospheric observations where satellite or sensor data exists.

• Train sustainability teams on thermodynamic fundamentals—First and Second Law implications, exergy concepts, and entropy production—as foundational MRV competency.

• Require third-party verification to include thermodynamic consistency checks, not merely procedural compliance with reporting standards.

• Build physical baselines for additionality assessment, modelling counterfactual energy flows under alternative scenarios rather than relying solely on financial tests.

• Document uncertainty budgets that acknowledge thermodynamic constraints on measurement precision, particularly for complex Scope 3 value chains.

FAQ

Q: How do the laws of thermodynamics constrain sustainability claims? A: The First Law (energy conservation) requires that all energy inputs appear as outputs or storage—claims of energy creation or disappearance indicate measurement error. The Second Law (entropy increase) establishes that no process achieves 100% efficiency; useful work capacity always decreases in real transformations. Together, these laws set absolute ceilings on efficiency improvements, minimum energy requirements for processes like carbon capture, and realistic bounds on circularity. Any sustainability claim that implicitly requires violating these laws—perpetual motion, perfect recycling, efficiency exceeding Carnot limits—is physically impossible regardless of technological advancement.

Q: What is "measurement theatre" and how does thermodynamic understanding help avoid it? A: Measurement theatre occurs when organisations generate impressive-looking sustainability metrics that lack physical meaning or verifiable connection to real-world outcomes. Examples include efficiency claims that exceed thermodynamic limits, Scope 3 estimates based on spend rather than physical flows, and circularity metrics that ignore material quality degradation. Thermodynamic understanding provides diagnostic tests: Do energy accounts balance? Do mass flows conserve? Do efficiency claims remain below theoretical limits? Organisations applying these checks catch measurement theatre before it reaches disclosures, building credibility with regulators, investors, and verification bodies.

Q: How does complexity affect sustainability measurement accuracy? A: Thermodynamic complexity theory establishes that measurement precision degrades predictably as systems grow more interconnected. A single factory's emissions can be measured with 5% uncertainty; a supply chain with 10,000 suppliers might have 50%+ uncertainty regardless of methodology. This has practical implications: Scope 3 estimates should include honest uncertainty ranges rather than false precision; circular economy metrics for complex material loops should acknowledge cumulative error; and verification efforts should focus resources on high-impact, lower-complexity measurement points rather than spreading thin across unknowable value chains.

Q: What European regulations require thermodynamic considerations? A: The CSRD requires energy consumption and GHG emissions reporting with assurance—thermodynamic consistency is implicit in credible assurance. The EU Taxonomy's technical screening criteria specify energy efficiency thresholds derived from thermodynamic limits for buildings, transport, and industry. CBAM requires embedded emissions calculations that depend on accurate energy and mass balances. The Energy Efficiency Directive references best available technology benchmarks rooted in thermodynamic analysis. While no regulation explicitly mandates "thermodynamic verification," the physical constraints embedded in technical criteria make thermodynamic literacy essential for compliance.

Q: How should organisations build thermodynamic competency in sustainability teams? A: Start with foundational training on First and Second Law implications—what conservation means for accounting, why efficiency has limits, how entropy constrains circularity. Introduce exergy concepts for energy-intensive operations. Require physical balance checks as standard procedure before finalising any emissions inventory or efficiency claim. Partner with engineering functions that already apply thermodynamic thinking to process design. Engage verification providers who include physical consistency in their assurance methodology. Over time, thermodynamic literacy becomes cultural: sustainability professionals instinctively question claims that seem too good to be physically true.

Sources

• European Financial Reporting Advisory Group, "CSRD Implementation Pilot Analysis," November 2024
• International Energy Agency, "World Energy Outlook 2024: European Energy Efficiency Trends," October 2024
• European Central Bank, "Climate Risk Stress Test 2024: Banking Sector Resilience Assessment," July 2024
• European Commission Joint Research Centre, "Thermodynamic Benchmarking for Industrial Efficiency," 2024
• European Securities and Markets Authority, "Sustainable Finance Data Quality Report," September 2024
• ISO 14064-1:2018, "Greenhouse gases — Part 1: Specification with guidance for quantification and reporting of greenhouse gas emissions and removals"
• Ellen MacArthur Foundation, "Material Circularity Indicator: Technical Methodology," 2023 revision
• Dincer, I. and Rosen, M.A., "Exergy: Energy, Environment and Sustainable Development," Elsevier, 3rd edition 2021