Companies with internal carbon pricing say this tool allows them to assess the financial implications of their carbon emissions and incentivizes them to shift to low-carbon initiatives. It also complements the emissions reduction regulations by governments under which businesses are subject to.
Others even lauded that an internal carbon price or tax helps them in achieving their climate goals while addressing shareholders’ concern about disclosure. While some businesses use it to help them prepare for future policies on carbon emissions.
So, what is internal carbon pricing (ICP)? How does an internal carbon price work for a company? Do businesses really pay for their emissions via a carbon tax? This comprehensive guide will answer all these questions and more about internal carbon pricing.
What is Internal Carbon Pricing?
The heavy emitting sectors have been using a business carbon pricing as part of their risk mitigation strategy since the 1990s. In particular, firms in the oil and gas, minerals and mining, and the power sectors are using this pricing tool to place a value on their carbon emissions in a manner that drives positive change in their business.
When an internal carbon price is set, a cost is assigned to every ton of carbon emitted. Companies can then factor that cost into their business or investment decisions, encouraging efficiency and low-carbon innovation.
According to 2016 disclosures to CDP (Carbon Disclosure Project), over 1,200 companies worldwide are either looking to set an internal business carbon pricing or preparing to do so. Most of them are in Europe and North America but businesses in emerging economies such as China, India, and Brazil have seen the highest increase in ICP use.
And as companies are getting more serious about taking climate actions, internal carbon pricing also becomes more vital in helping the world transition to a low-carbon economy in 2023 and beyond.
If your company is also considering having an internal carbon price in place, then you need to know that it comes in three major types.
3 Types of ICP
There’s no definitive answer on what your company’s carbon price should be. Plus, there are also many different ways that the cost of carbon can be integrated into your business operations.
That only means that the best starting point for your business when pursuing internal carbon pricing is to understand your own drivers for it. To help you with this, here are the forms of internal carbon price you can consider.
Internal Carbon Tax
An internal carbon tax is a monetary value on each ton of carbon emitted by your business activities. This is readily understandable throughout your company. You just have to keep a record of and report those activities.
The collected fee becomes a revenue that your company can use to fund its emissions reduction efforts. While there’s no exact amount of tax to follow, the internal carbon fee you can charge ranges from $5-$20 per metric ton.
Setting the fee requires consideration of all internal factors across the business impacting the tax levied. The practicalities involved as to how the money can be collected should also be considered.
An alternative to imposing an internal carbon tax is designing an emissions trading system such as the EU ETS. It works like the cap-and-trade schemes used by the governments today.
It’s basically placing a limit or cap on how much carbon can a business unit or activity emit. Any excess will be charged accordingly by how much is the value of each ton. Typically, the price is set much lower than a shadow cost price.
Shadow Carbon Price
This internal carbon pricing sets a theoretical or assumed cost per ton of carbon. Not being a real price, this may be easier to implement as there’s no need to make changes in your business unit budgets or financial allocations.
Under this pricing method, a cost of carbon is determined within business processes which include:
business case assessments,
procurement procedures, or
business strategy development.
The goal is to show the cost of the carbon implications of those business decisions, which can then be communicated to stakeholders.
Usually, a shadow price is set higher than an internal carbon tax to reflect the expected future price of carbon. It varies a lot, from $2 to ~$800 per ton.
Shadow cost pricing helps your business understand carbon risk and prepare appropriately. And that’s before the hefty shadow price becomes a real carbon price.
Implicit Carbon Price
An implicit price is based on how much a company spends to cut carbon emissions on projects like renewable energy. It also takes into account costs of complying with certain government regulations.
Any firm with climate related goals has an implicit price on carbon emissions. The prices can even appear several times within the same company. You can use them to specifically identify which costs to minimize and better know your emissions.
You can even use this price as a basis for determining and launching an internal carbon price for your business.
Though each type of internal carbon pricing varies, many companies use a hybrid of approaches combining their different attributes.
But how exactly does an internal carbon price work for your company? Why is establishing it important for your business? Let’s break it down in the next section.
How Does an Internal Carbon Price Work For a Company?
Right now, there are no international standards that businesses should meet when setting up their internal price on carbon. So how it works for your company is really up to you.
And despite lack of standards and regulations, opting to implement an internal price is beneficial for many reasons.
After all, there are some helpful guides and initiatives you can still look to such as the Caring for Climate initiative from the UN Global Compact. It encourages firms to become a Carbon Pricing Champion by setting an internal carbon price, communicating progress, and advocating for its importance.
Also, Canada recently launched its Global Carbon Pricing Challenge at COP27 climate summit in Egypt. It makes existing pricing systems more effective and support other nations when adopting carbon pricing.
Internal carbon pricing helps companies in managing their climate-related business risks. ICP can also serve as an important risk-mitigation tool with multiple benefits beyond your company’s operations, customers, and communities.
The signals are out there that carbon risks are real and they’re coming fast.
Last year, the Bank of England warned businesses to be ready to pay for carbon prices that can soar up to $100/ton. Likewise, the UK government also requires companies to report on their carbon-related risks by 2050.
Moreover, governments have been busy closing deals in line with their Paris climate goals. And the recent COP27 summit closed a lot of those deals, prompting countries to introduce carbon pricing mechanisms as part of their decarbonization strategy.
What that means is that the timeline for a change is now clearer than ever.
The best part? Your company will not only be prepared for that change but will also enjoy the benefits of having an internal carbon pricing system.
The Benefits of ICP
The drivers of ICP are specific to each company but in general, it brings the following major advantages.
Prepares for future regulation
Firms that track their GHG emissions and implement an internal price on carbon are better prepared for a regulatory future in which carbon is priced. In a sense, the mechanism helps your company in de-risking against future carbon price and future-proofing its business strategy.
Addresses sourcing requirements
Companies that source or operate internationally are exposed to certain carbon pricing standards. This makes them a subject to the existing global patchwork of carbon emissions regulations. So, if you intend to operate globally, it’s a good idea to start calculating, monitoring, and pricing carbon emissions to make it easier to work your way around international pricing policies.
Promotes carbon innovation and efficiency
Pricing carbon bolsters innovation and efficiency improvements, provides a new lens for capital investment decisions, and inspires carbon efficient technologies. It also makes emissions intensive business practices more costly, urging firms to avoid them.
Plus investors are starting to prioritize ventures that promote corporate sustainability, including internal carbon pricing, and are increasingly investing in them. So, it generates finance for sustainability initiatives.
Broadly speaking, ICP also helps make carbon considerations more central to business operations while enabling companies to respond to investors’ concerns on climate.
Given these benefits, do businesses pay a carbon tax? Or better yet, do they really have to pay for their carbon emissions with a tax?
Do Businesses Pay a Carbon Tax?
A carbon tax is considered as an essential policy tool to control carbon emissions: high prices for carbon-emitting products and services reduce demand for them.
A carbon tax is generally levied on fossil fuels that businesses have to pay. While most companies are emitting carbon and other GHGs, not all of them are paying carbon taxes.
According to the World Bank, there are 68 direct carbon pricing instruments operating as of June 2022 in 46 national jurisdictions around the world. These comprise 36 carbon tax regimes and 32 emissions trading systems (ETS).
Source: World Bank
ETS are tradable-permit systems which set a cap on the amount of greenhouse gasses that can be emitted. Businesses and entities have the flexibility of buying and selling emissions units, popularly known as carbon credits.
Some countries have already adopted a carbon tax while discussions are ongoing in others. There are also proponents of setting up a global carbon tax. But governments often prefer to use measures other than a tax to contain emissions for some reasons.
For example, mandating carbon taxes can be politically difficult because some sectors of the business community may oppose such a tax for financial reasons. Carbon taxes are also often regarded as regressive as they can penalize poorer members of society by contributing to price rises.
Another complicating factor is the so-called “carbon-leakage”. This means businesses may try to move their operations to other countries with less strict emissions policies. This can still increase the countries’ total emissions.
And among countries that have a carbon tax, the levels vary a lot and other measures exist alongside it. ETS is one of them as aforementioned as well as internal carbon pricing.
So what companies have an internal carbon tax or price in place?
Companies With Internal Carbon Pricing Programs
Business carbon pricing becomes most meaningful if it’s embedded into a company’s business strategy.
Some firms use revenue from its internal carbon tax to fund projects that reduce emissions such as renewable energy and energy efficiency. Popular names include Microsoft, Shell, BP PLC or British Petroleum, and more.
Others are also embedding a shadow price in their strategies by shifting investments into low-carbon assets. More and more businesses follow in their footsteps and experiment with internal carbon pricing.
In Europe, ICP was a key factor in an energy firm’s decision to close several of its power plants. In the U.S. some financial services companies use internal carbon pricing to identify high-return, low-carbon investment opportunities.
But a question rises if their pricing thresholds are correct.
A leading management consulting firm McKinsey & Company looked at data from companies that have disclosed internal carbon pricing programs. Their analysis revealed that there’s growing interest and varied ways in how companies use these pricing mechanisms.
In particular, 23% of around 2,600 companies said that they’re using an internal carbon tax or fee while 22% of them plan to do so in the next 2 years.
The top firms that reported the most were from the energy, materials, and financial industries, and then followed by the technology and industrial sectors.
A geographic analysis shows that 28% of companies in Europe are using an internal carbon price. Japan (24%), the UK (20%), and the U.S. (15%) have the highest percentages of companies using the pricing mechanism.
The findings also show that price thresholds per ton of carbon used vary widely by industry and region.
For instance, in Asia it’s only $18/ton while it’s higher in Europe, $27/ton. With this, companies are choosing values that are most useful for their regions and business contexts.
The chart below reveals the high variability of internal carbon prices within and between regions and industries.
To address this huge difference in the internal cost of carbon, attempts are underway to help firms determine optimal pricing standards. Some industry groups suggested potential pricing levels ranging from a few dollars to above $100/ton.
Yet, the issue remains a topic for debates.
Nonprofits argue that the social cost of carbon is far above $50/ton of emissions. Others further said that such a number is far lower than it should be as it doesn’t include significant impacts of climate change.
In the U.S., researchers determined that the social cost of carbon in the country should be at $185/ton. That’s over 3x than the current social cost of carbon which is a $51/ton.
Meanwhile, an expert group estimates that companies need to set internal carbon pricing between $40/ton and $80/ton in 2020. But that should go up between $50/ton and $100/ton by 2030 to reduce emissions in line with the Paris Agreement.
In contrast, the majority of the companies that have internal carbon pricing in place have thresholds at about $40/ton only.
Accounting for carbon emissions and paying for it is just one way for companies to manage climate-related risks, strengthen corporate values, and improve their investment decision making. But it’s a good step to take.
To date, internal carbon pricing initiatives by companies impact 22% of global GHG emissions, up from 15% in 2017. But as the analysis suggests, their pricing thresholds are far lower than they should be to account for all the costs of emitting carbon.
So, if companies want their business decisions to completely reflect the real costs of carbon emissions, they should take a closer look at their existing internal carbon pricing programs and then re-assess them.
This means you should do more research and analysis of your own business operations before deciding how much to pay and then make the first move, which is calculating the price of carbon your company should set internally.
Calculating Internal Carbon Price
This can be done in many ways. One way is by referencing externally published sources to reflect the associated risks. Examples of these are the UK Green Book guidance or the CDP Carbon Pricing Corridors.
You can also link them to determining the cost of carbon offsets you plan to use. They are credits you can buy to neutralize emissions that your company can’t avoid or reduce. This can go when considering a shadow price.
When it comes to measuring an implicit carbon price, it is based on an understanding of how much your company spends on reducing GHG emissions. This is necessary to know where carbon is emitted the most in your business and cut them appropriately.
If you want to go for a more complex method of including the social cost of carbon in your internal pricing, then you have to factor in all the quantifiable costs of emitting a ton of CO2. This method will take in a much wider range of social impacts into your calculation.
Overall, regardless of which form of internal carbon pricing your company chooses to take, pursuing it may worth your time and effort. After all, setting a price on carbon seems to be the inevitable future of doing business to keep the planet from heating up.
Should you want to learn more about carbon pricing in general and how it works, just take a few more minutes and read our guide here.