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Q&A | Implementing Internal Carbon Pricing

May 24, 2022 | Insights,

ICP definition: A mechanism by which companies can put a value on their greenhouse gas (GHG) emissions in a way that drives positive change in their business.

Explore the ICP Guide

Why is ICP becoming such a trending business practice?

There has been a high uptake and enthusiasm for Science-Based Targets (SBTs) and Net Zero targets over the last few years. Achievement of those targets requires business decisions to change. ICP is a simple but powerful mechanism to achieve these targets by embedding them into business practice.

Carbon Disclosure Protocol (CDP) returns, Task Force on Climate-Related Financial Disclosures (TCFD) requirements, and the news coverage around the external cost of carbon and the rising price of the EU Emissions Trading Scheme (EU ETS), are all increasing awareness around ICP.

What are the different types of ICP mechanisms?

There are two main ICP models – carbon fee and shadow price. In addition, implicit price is a metric to measure the cost of reducing carbon in an organisation and can be used across both models.

1.Carbon fee models create a levy on the price of carbon, e.g. an additional charge for booking business travel which goes into a central fund.

2.Shadow pricing applies a cost of carbon to the decision-making process, but the cost is not levied. For example, in a project assessment, the carbon impact of the project is quantified and then monetised using a $/tonneCO2e. The resulting financial figure is taken into account in the decision, but that carbon-related value is not charged.

The main aim when designing an internal carbon price is to meet the right needs and drivers for the business and understand the human factors.

What factors are considered when setting an internally applied carbon price?

When setting the price there is a range of factors to consider. If external tax risk is a driver, a regulatory price such as the EU ETS should be included in the analysis. However, when reviewing external risks, your organisation should consider carbon tax risks in all operating countries, as variations can occur. Another external factor is the price of Renewable Energy Certifications and offsets. Bloomberg recently published an analysis suggesting that offset prices could reach $200/tonne by 2030.  As companies race to Net Zero and achievement of interim SBT targets, the demand-supply dynamics are likely to affect the prices of certificates significantly. 

Internal factors must be considered including the implicit cost of carbon for the organisation and the cost of changing behaviour. The human factor is important to get the balance right, as ultimately ICP is about driving behaviour. The choice of the carbon price is about achieving the best outcome at the best price. 

What are the resources needed to implement the ICP mechanism?

The key resource that is required when implementing an ICP is data. Organisations will need to quantify the carbon impact of the ICP mechanism. At one end, there are simple, already calculated annual corporate footprints that could be used to apply a charge to departments. ICP could also focus on an area like business travel, where the data is relatively easy to collect and improve. Alternatively, organisations could quantify the impact of individual business cases, which requires access to data that supports the carbon quantification of the project.

How can investors help implement ICP?

Investors can use ICP to make divestment decisions. When a carbon price is applied to particularly carbon-intensive sectors, it can make investments look less attractive.

ICP needs to be applied sensitively to account for the opportunity to improve carbon emissions, not just penalise those currently underperforming. To model this effectively, and make those informed decisions, requires significant engagement with companies to understand their potential to change and the plans currently in place. Accessing CDP data can be one way of approaching this or more direct engagement to request specific data returns.

ICP can be useful as a flag, particularly where shadow carbon pricing is used, i.e. highlighting risks and identifying priority companies to work with. How that information is then used in decision-making must be thought through with the aims of the organisation in mind.

How can carbon rationing policies within organisations drive individual accountability?

Carbon rationing can be used with great effect when well thought-through. Whether to impose those rations on all, or just some, individuals is an important question to work through and will be related to the level of individual autonomy there is within roles. It is a different thing to apply a limit to the director of a department who is deciding on strategy, than it is to apply it to a factory floor worker. Carbon rations can still inspire the required behaviour, even when not applied individually. We are social animals, so where we have a strong group culture and an issue is communicated and incentivised in the right way, individuals will get behind the cause.

It is worth stress testing the use of this method in a pilot phase and thinking through the implications of what choices individuals have when the limits are reached. Working through the guidance, training, governance of the system, how limits are set, how limits and effects of the system can be reviewed, and range of options open to individuals is important.

What is the guidance to implement ICP?

I would recommend thinking about the three letters of the acronym separately: 

  • I – Internal is important for understanding what your drivers are, the stakeholders involved, and who is affected? What are the internal and external issues? This takes a systems approach.  
  • C – Carbon is all about the data practicalities of what data do you need? What is the quality of the data? What are the supporting processes and tools that help quantification?  
  • P – Price is where you want to take account of the external carbon tax risks, implicit price, the price needed to change behaviour, cost of late action, and cost of growth in the carbon footprint 

Can internal carbon pricing be used to tackle scope 3 emissions?

Internal carbon pricing can be used on almost any part of your business and GHG inventory, including tricky scope 3 decarbonisation, such as business travel or purchased goods and services.

When undertaking an ICP scoping study, we ask, “what areas of your GHG inventory are a) hotspots/sizable b) difficult to reduce”. ICP is ideal for tackling these areas.

For areas that are hard to reduce, it is often due to challenges with making the case for green and innovative alternatives. Internal carbon pricing helps make the case for lower carbon options by presenting the real carbon-related risks and externalities that need to be considered when making decisions for the business. For GHG inventory hotspots (i.e. the biggest areas of your inventory), ICP helps focus attention in that area and align thinking and decision making on what your decarbonisation priority needs to be. For most organisations, scope 3 emissions fall under both categories of being hotspots and being difficult to reduce.

The challenge with including scope 3 emissions is primarily the quantification of those emissions. Scope 3 emissions are typically harder to quantify than scopes 1 and 2. However, quantification is possible and there are many useful factors, benchmarks, and approaches that are used within scope 3 GHG calculation that can be used during the ICP process. A well-designed system will look at the available data and the pragmatic balance between accuracy and ease of use, while aligning with what is necessary to ensure standards are met and that communications are robust and fit for purpose.

What ICP standards should be followed?

There are no specific ICP standards, but there are useful sources of guidance available, including the Carbon Pricing Leadership Coalition.

Part of the reason for the lack of standards is that the concept of internal carbon pricing is relatively new and it can be used in myriad ways. However, there are elements of implementing ICP that should follow existing standards, most importantly for quantification of carbon impacts. A key part of any ICP process is quantifying the carbon impact (be it from a business flight, an investment project, or a whole department or subsidiary’s GHG footprint). That quantification should follow the GHG protocol so it aligns with other GHG reporting and quantification that the organisation undertakes.

In some instances it may be necessary to be aware of and align with more detailed standards related to other business processes or standards used within the organisation, such as Life Cycle Assessment or procurement practices. Robust scoping before implementing ICP will help identify these requirements.

There are voluntary means of reporting ICP, such as CDP returns. There have been (and will likely continue to be) consultations regarding upcoming regulations on carbon reporting in different geographies that consider whether companies should be mandated to use or disclose an internal carbon price. As yet, there is nothing in place that mandates the use or details of ICP reporting.

What guidance does the CSRD provide on Internal Carbon Pricing?

The Corporate Sustainability Reporting Directive (CSRD) puts new requirements in place for corporate sustainability reporting. The law requires that new European Sustainability Reporting Standards (ESRS) are developed to define the content companies are required to report on. The draft ESRS contain several references to Internal Carbon Pricing (ICP) and some guidance that supports the implementation of ICP schemes.

Section E1-3 (Actions and resources in relation to climate change policies) and section E1-4 (Targets related to climate change mitigation and adaptation) require organisations to collect data that provides an important basis for calculating their implicit price. The implicit price is a powerful metric and a great starting point for any organisation developing an internal carbon price as it represents the actual cost of carbon that an organisation will face in meeting its targets. For many organisations, this cost of carbon will be far more material than external taxes.

The ESRS guidance also contains a specific section on ICP (E1-8  – Internal Carbon Pricing). The guidance requests that the methodology for determining the internal carbon price is explained and the price stated. This may cause concern as many organisations have been reluctant to share this information.

The ESRS does not provide specific guidance on how an internal carbon price should be set or calculated but does suggest an appropriate level of rigour. This includes that the carbon price should be based on an analysis of what is suitable for the application in question (e.g. what area of the business is the price applied to?) and the undertaking should disclose “the extent to which these [prices] have been set using scientific guidance and how their development is related to science-based carbon pricing trajectories”.

The CSRD regulations are notably looking for the application of “double materiality”. Double materiality is the requirement for undertakings to report on both sustainability matters and financial matters or their “impact materiality” and their “financial materiality”. Double materiality requires measurement of the activities that impact the company’s bottom line in a financial sense but also those impacts that the company has on society and the environment with the understanding that these are not immune from impacting the bottom line, i.e. that there are costs associated with them. Internal Carbon Pricing is a key tool for understanding, representing, and communicating these impacts and risks. Anthesis’ approach to ICP aligns with the requirements and intent of the CSRD regulations.

Find out more about our approach to the CSRD

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