Internal carbon pricing
Of about 6,000 companies surveyed on carbon pricing in 2020 by CDP, more than 2,000, representing over US$27 trillion in market capitalization, disclosed that they currently use an internal carbon price or plan to implement one within the next two years.
Carbon pricing is the cost applied to greenhouse gas emissions in order to bring down polluting activities and drive investment to cleaner options. In this edition we are going to focus on Internal Carbon Pricing or ICP which is the system by which companies charge their internal departments for their emissions.
What to expect today:
What is internal carbon pricing?
Internal carbon pricing (ICP) is a mechanism by which companies can put a value on their greenhouse gas emissions in a way that drives positive change in their business. It also helps them achieve their greenhouse gas targets, address shareholder concerns about disclosure, build resilient supply chains, gain a competitive edge, and showcase corporate leadership.
Types of internal carbon pricing
Internal carbon pricing can serve as an important risk-mitigation tool with multiple benefits beyond the company’s operations, customers and communities. The tax money collected can also be used to fund climate tech projects. Below are the three ways companies are implementing carbon pricing:
Shadow cost pricing
Shadow cost pricing is a theoretical or assumed cost per ton of carbon emissions which 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
It helps a firm understand carbon risk and take appropriate actions
The charge is theoretical is not really incurred by departments - it’s just a way of converting the impact of carbon emissions into dollar amount without charging internal departments
Companies can choose to impose their own internal carbon tax which is applied against carbon emissions by internal teams.
In an Internal tax or trading system, the “tax” is levied for real and is deducted from the P&L of internal teams.
Usually the price is set much lower than a shadow cost price.
An implicit price is based on how much a company spends to reduce greenhouse gas emissions and/or cost of complying with government regulations
For example, it can be the amount a company spends on renewable energy purchases or compliance with fuel economy standards. It helps companies identify and minimize these costs, and use the information gained from this to understand their own carbon footprint
An implicit carbon price can set a benchmark before formally launching an internal carbon pricing program
Corporate pricing is most meaningful if embedded in a company’s business strategy. Some companies, such as Microsoft, use revenue from its internal carbon fee to fund green projects. Others, such as Shell, BHP, and BP, embed a shadow price in their business strategy by shifting investments in low-carbon assets or even stopping projects with high-carbon intensity.
How much is actually levied in an internal carbon pricing system?
CDP’s analysis found that the median internal carbon price disclosed by companies in 2020 was US$25 per metric ton of CO2, with companies in Asia and Europe implementing the highest average price of US$28.
High-Level Commission on Carbon Prices, a voluntary, multi-stakeholder partnership, hosted by the World Bank Group, has estimated that companies would need to set internal carbon pricing between $40 and $80 per metric ton in 2020 and between $50 and $100 per metric ton by 2030 to reduce emissions so they are in line with standards set in the Paris Agreement.
Implementing carbon pricing
With the urgency of the climate crisis, it is important for companies to take positive steps and prepare for a world where they will be additionally taxed for their carbon footprints. Internal carbon pricing will help companies to improve energy efficiency, to reduce financial impact on business as governments draft regulations for companies to implement carbon pricing systems.
For example, The California Cap-and-Trade Program aims to reduce California’s GHG emissions by achieving 80% reduction from 1990 levels by 2050. Under the program, the state sets a declining cap on emissions in accordance with emission reduction targets and generates a number of credits under the cap. For example, If an entity in California creates GHG emissions as part of its activities—for example, electricity generation, manufacturing, or fuel refining—it must comply with the program by purchasing credits (or allowances) in an amount equal to that level of emissions. If the company is operating under the cap set by the government, they can even sell their credits to other companies to comply with the regulation.
Check out this dashboard which shows the current state of regulations across the world on carbon pricing.
Carbon pricing has emerged as a key policy mechanism to mitigate the dangerous impacts of greenhouse gas pollution. The number of companies disclosing to CDP that they embed an internal carbon price into their business strategies has grown from 150 global companies in 2014 to over 850 companies in 2020. Today we look at how internal carbon pricing is implemented at three companies; Microsoft, Disney and Shell.
In 2012, Microsoft made a company wide commitment to become carbon neutral. In order to meet that goal, Microsoft chose to implement an internal carbon fee that allocates the cost of becoming carbon neutral across its major business units. Each quarter, Microsoft tracks and analyzes its energy use from data centers, offices, labs and manufacturing, as well as emissions associated with business air travel, which are later converted into tonnes of carbon.
Microsoft’s initial carbon fee focused on scope 1, scope 2 and business air travel. Scope 1 emissions come from direct operations, scope 2 is from electricity and scope 3 is from procurement, supply chain, product energy use and categories such as business travel and employee commuting. With all the information, they charge their business groups a certain amount in carbon fees. The price of the internal carbon tax is set at a modest $6 to $7 a ton, which is to be increased at $10/ton.
In 2022, Microsoft redesigned and increased their carbon fee to accelerate scope 3 emissions reduction and match the underlying costs of carbon reduction. For example, the scope 3 business travel fee will increase to $100 per metric ton of carbon dioxide equivalent in their next fiscal year to bring down scope 3 emissions.
In 2009, Disney announced a series of long-term goals to reduce its environmental impact, including a goal of zero net direct greenhouse gas emissions. Disney’s voluntary offset program has covered the Scope 1 direct emissions through energy efficiency and fuel savings initiatives.
As part of this effort, Disney established its Climate Solutions Fund, the name given to its internal carbon pricing program. The costs of carbon offset projects are charged back to individual business units at a rate proportional to their contributions to the company’s overall direct emissions footprint. Charging the business units for their GHG emissions raises the capital that is used to invest in third-party emission reduction projects.
Disney adopted a carbon fee in 2013, ranging from $10 to $20 per metric ton of CO2, using the money to offset its emissions with forestry carbon credits. It has now been raised to $35 per ton.
Shell uses a shadow carbon pricing method for current and future projects. It uses an internal carbon price of $40 to $80 per metric ton since 2000 to evaluate investment decisions.
For example, imagine that the company was comparing two rival natural gas projects in different basins. Let's assume that the projects were equal in value but that in one case the gas produced from the subsurface naturally contains 10% CO2. It's normal practice to strip out the CO2 to make the methane marketable and then for the CO2 to be vented directly to the atmosphere, typically with no payment of any carbon tax penalty. Under the shadow carbon pricing program, Shell would choose the project in the basin with the CO2-free gas, other things being equal. Although this would provide no immediate financial benefit, it would reduce the company's emissions and would lower its future liabilities in the event that the vented CO2 becomes taxable.
Shell emitsabout 80 million tonnes of CO2 annually from its operations. At a carbon price of $40/tonne, that amounts to an imputed cost of $3.2 billion per year. However this is nothing compared to the 600 million tonnes of CO2 Shell’s customers emit from the gas Shell provides them.
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