A Guide to Internal Carbon Pricing

May 7, 2021 | Guidance,

What is internal carbon pricing?

Internal carbon pricing (ICP) is 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.

While the word “carbon” comes up repeatedly in discussing this topic, what is meant is CO2e (Carbon dioxide equivalent) or your GHG emissions.

When an internal carbon price is set, a cost is assigned to each ton of carbon used so this can be factored into business and investment decisions, incentivising efficiency and enabling low-carbon innovation.

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Setting an internal price on carbon

Currently, there are no international standards that businesses can seek to comply with when setting an internal price on carbon (in the way they might for setting a Science Based Target or reporting to the Carbon Disclosure Project, for example). But there are still some helpful guides and initiatives that businesses can look to, such as the Caring for Climate initiative from the UN Global Compact. This initiative encourages companies to become a Carbon Pricing Champion by setting an internal carbon price, communicating progress, and advocating for the importance of carbon pricing.

Similarly, there is no definitive answer or source for companies on what your carbon price should be, and there are a variety of ways that the cost of carbon can be integrated into business practices. This means that the most important starting point for a business considering internal carbon pricing is to understand their own drivers for setting an internal carbon price.

Click below to explore the ICP Guide:

Why implement an ICP
Benefits of an ICP
Types of Carbon Pricing
How to calculate your ICP
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Why does your business need an internal carbon price?

So, if there are no standards to sign up to, no definitive carbon price, and no regulations currently driving internal carbon pricing, why would a business choose to implement such a scheme?

The signals are out there that carbon risk is real and its realities are fast approaching. In January 2021, the Bank of England cautioned businesses to prepare for carbon prices to rocket to $100 per ton.  Additionally, the UK Government has set out a pathway that will require UK businesses to report on their carbon-related risks by 2050, aligned to the TCFD (Task Force on Climate-related Financial Disclosures ) reporting standards. As some industries are already mandated, in particular those which invest in other parts of the economy, companies should expect to experience a trickledown effect of interest where carbon-related business risks reside. And, with governments signed up to carbon reduction targets in line with the Paris Agreement, many are introducing carbon pricing mechanisms to cut emissions. This makes the timeline for change far clearer than it has ever been.

Benefits of setting an ICP

Setting an internal carbon price can also provide significant benefits. While the drivers are specific to each company, in general the benefits of ICP schemes are:

  • Making carbon considerations more central to business operations and understanding
  • De-risking against the future carbon price
  • Understanding carbon and carbon risk in the business
  • Future-proofing your business strategy
  • Generating finance for sustainability initiatives
  • Raising awareness internally and externally
  • Answering to investors and consumers and responding to their concerns regarding the climate emergency
  • Reducing carbon emissions

Carbon emissions that you are responsible for, and those in your supply chain, are a risk to your business. Many businesses are asking how they can be ready to survive and thrive in a carbon constrained future. Setting an internal cost of carbon can align with and support a carbon management strategy and achievement of Net Zero or Science Based Targets (SBTs).

Explore carbon pricing across the world with the CDP interactive map.

Using the shadow cost method, the cost is not realised or taken out of the business, instead, it is a “for information” metric regarding future risk. For example: this investment or business decision would cost us more by a factor of X if there were an external cost of carbon imposed upon us.

 

Types of carbon pricing

There are two main mechanisms via which a business can implement an internal carbon price: shadow cost pricing or an internal tax or trading system.

Shadow cost pricing

Shadow cost pricing is a theoretical or assumed cost per ton of carbon emissions.

With the shadow cost method, a cost of carbon is calculated within business processes, such as business case assessments, procurement procedures, or business strategy development, to demonstrate the cost of the carbon implications of those business decisions. The resultant cost can then be communicated to stakeholders.

Typically, the price is set high to a level that reflects the expected future price of carbon, such as the $100 per ton Bank of England prediction mentioned earlier. The shadow price of carbon method helps a business understand carbon risk and then prepare appropriately, well before the shadow price becomes a real price.

As a theoretical price, it may be easier to implement within a business as there is no change to department budgets or finance arrangements.

In an Internal tax or trading system, the “tax” is levied for real. The specific mechanics of how money is transferred within the business must be designed to fit the needs of the business.

Internal Tax or Trading System

Alternatively, companies can choose to impose their own internal carbon tax or trading system that is calculated across business departments.

In an Internal tax or trading system, the “tax” is levied for real. The specific mechanics of how money is transferred within the business must be designed to fit the needs of the business. Typically, the price is set much lower than a shadow cost price.

Setting the price requires consideration of sensitivities across the business towards having such a tax levied and practicalities of how the money can be realised. There are various flavours of this kind of carbon pricing, such as the creation of a central pot or designing a system of allowances and trading, or Cap and Trade, that mirrors external mechanisms such as the EU Emissions Trading Scheme. The money raised by this method would typically be re-invested into sustainability and carbon reduction projects.

This system is beneficial in raising funding for investment in carbon reductions and incentivising change.

How can you calculate your internal carbon price?

Once you have decided on the mechanism that you will use to implement your internal carbon price, you then need to decide how you will calculate it. There are various ways that the carbon price can be calculated, including the following options:

  • Externally published sources – For a shadow price method, it is preferable to link your carbon price to an externally published source to reflect the element of risk. There are a variety of sources that can be used, such as the UK Green Book guidance or the CDP Carbon Pricing Corridors. It could also be linked to the cost of appropriate offsets, or the costs of external mechanisms such as the EU Emissions Trading System (ETS). Using an externally published source can also be beneficial for your governance processes and in being able to keep your ICP system up to date.
  • An internal bespoke carbon price – For an internal tax or trading system, the calculation of an internal bespoke price would typically be more appropriate. The price would be set with internal sensitivities in mind and should be reviewed regularly to understand the impact it is having in decision making and in business operations.
  • Implicit price – An implicit price is calculated from an understanding of how much the company spends on reducing GHG emissions. This is then applied to the understanding of where carbon is emitted in the business. It may be that a target is already in place along with a program of investment. The implicit price can be used for communication or allocating cost across the business.
  • Social cost of carbon – Some businesses may want to consider the social cost of carbon (SCC). This is a more involved and complex method that adds up all the quantifiable costs and benefits of emitting a ton of CO2 and typically takes in a wider range of social impacts into the cost calculation.

In truth, setting a specific carbon price is not the most difficult or even the most important element of internal carbon pricing. The impact and effectiveness of an ICP strategy will come from the appropriate design of the implementation mechanism. This must fit into and complement existing business systems, while also addressing your most pressing carbon-related business drivers. It is also important to consider just how you can quantify the carbon-related impacts of your business in a way that is streamlined, accurate and fit to purpose.

How can Anthesis help?

Anthesis can support businesses with the creation of internal carbon pricing mechanisms through stakeholder engagement, our in-house tools, and our network of experts. We can work with you to identify the mechanism that suits your business needs and then design a process that fits into, and works with, your existing data, business processes and management structures.

For more information on how to identify if your organisation would benefit from internal carbon pricing and how to get started, contact us.

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