Internal Carbon Pricing

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.

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.

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.

Find out more about scope 1, 2 and 3 emissions >

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

Recent guidance from the Science Based Targets Initiative formalises the idea of a Science Based Carbon Price, which boiled down is about using a carbon price which reflects robust costs of relevant carbon based risks.

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. TCFD disclosure recommends disclosure of Internal carbon prices where used along with citing ICP as a key cross-industry climate related metric. The EU Corporate Sustainability Reporting Directive (CSRD) will mandate the reporting of Internal Carbon Pricing mechanism details.