In 2015, with the signing of the Paris Agreement on Climate Change, 195 countries committed to reduce their carbon emissions. This recognized transition towards a more sustainable world will eventually require the development of low-carbon technologies but also innovations in financial practices. Setting a tax or a price on carbon is one way to help companies account for their emissions.

According to the World Bank and as depicted below, over 40 countries and 20 provinces or cities have already implemented or are currently implementing a carbon pricing system[1]. An example is the European Union Emissions Trading System (EU ETS), which regulates installations responsible for 40% of the total EU greenhouse gas (GHG) emissions but nonetheless criticised by some for its relative inefficiency. Still, 13% of global emissions were subjected to pricing schemes last year. This figure is expected to grow and reach 25% by 2020 and 50% in the next 10 years.

Figure 1 – Global overview of direct carbon pricing in 2016 (I4CE & EpE, 2016)

What is happening at a company level?

In parallel to these large-scale emissions schemes, corporations have started to develop and implement their own carbon pricing mechanisms. A growing number of companies assign a price to the amount of greenhouse gas they emit. This practice is called Internal Carbon Pricing (ICP), which is said to stimulate decision-makers to invest in efficient and low-carbon projects. In addition, an ICP system can also help companies reach their emission corporate goals, drive R&D, or prepare them for future climate policies.

However, in a recent study, CDP (Carbon Disclosure Project[2]) revealed up to 800 companies are still not using an internal carbon price and thus may be vulnerable to the effects of current and future regulation mechanisms. In front of this hot topic, Greenfish is here to raise awareness, involvement, and commitment in your organization.

From the 150 global companies in 2014 that were already using an internal carbon price (or had planned do to so within the next two years), this number has steadily grown to almost 1,400 companies in 2017.  It represents more than 100 Fortune Global 500 companies with collective annual revenues of about US$7trillion, placing emphasis on the fact that carbon risk management is a business imperative[3]

Figure 2 – Growth of internal carbon pricing

 

Here at Greenfish, we are keen on advising companies and helping them to decarbonise their activities. Therefore, we would like to know if your company uses or is thinking about using an Internal Carbon Pricing system. If the answer is yes, how effectively is your ICP being deployed? Otherwise, you will find in this paper some tips to answer the question: why should your company start thinking about an ICP?

What is an Internal Carbon Pricing?

A Corporate ICP aims at internalising the economic costs and effects of the carbon emissions related to the company’s activities. It is a value fixed voluntarily by a company that will help take the right sustainable decisions regarding the global strategy. Therefore, it becomes more flexible to future regulatory climate policies and engages them towards a decarbonisation process. Internal carbon pricing primarily takes two forms (I4CE & EpE, 2016):

– A shadow price: it represents a carbon value (set by the company) that is integrated into investment decisions and applied to the GHG emissions generated by projects. It supports projects that reduce emissions and de-prioritises projects that generate emissions;

– An internal carbon tax: a tax that companies voluntarily apply to their operations and that increases operating costs depending on the resulting greenhouse gas emissions. The implementation of such tax involves transfers of real funds within the company which can then use them to fund low-carbon projects.

The ICP’s degree of influence: a burning issue

In order to really benefit from the advantages linked with an ICP system, it is important to grasp what degree of influence it has on business decisions. Indeed, there are diverse ways to take an internal cost of carbon into account with contrasting impacts on the global strategy.

Although first good steps, tracking carbon prices without directly affecting them to business decisions or only including the price into cost calculations as a passive indicator are known to be of weak influence. Furthermore, such implementations of an ICP system were announced in the last CDP report[3] to be quite ineffective and not strong enough to attract investors confidence. Investors are looking for more insights than just the carbon price a company is using: they also want details about how a company is using it and to what degree it influences the decision-making process.

On the other hand, the best ICP practice would be for companies to use their collected funds to finance innovative projects related to the reduction of GHG emissions, reward low-carbon decisions, and impose the ICP as a pivotal criterion in business choices.

A guide to corporate ICP: how to implement and use it?

It has been stressed that an internal carbon pricing system is a valuable tool only when there is proper attention given to the quality of its implementation. The key steps below will help you set it up effectively:

  • The first objective is to clearly understand the company’s ambitions and to evaluate the usefulness of an ICP system. This can be done by assessing its carbon footprint, identifying the highest level of GHGs sources, and determining the possible changes for reducing emissions.
  • Then, the company should analyse the measures and initiatives already in place and aim for the decarbonisation of its activity, the “implicit price of carbon”[4], so that the ICP system does not have a negative overlapping effect.
  • Next, it is important to persuade people within the company by developing a proper internal awareness of climate change’s impact on the company’s activities. By drawing from our experience at Greenfish, we believe that convincing people and departments in the company can be difficult, yet essential, especially obtaining the commitment of the financial department.
  • Afterwards, with the help of all the information gathered previously, it is time to define the most suitable mechanism and level for the internal pricing system as well as its scope of application. The choice is not definitive and can be enhanced via simulations or applications on past activities.
  • Eventually, after finding the right price(s), the company should run some trials and introduce performance indicators to assess the effects of implementing an ICP system. At this point, the programme can be fully launched and latter modified to better meet the targets fixed earlier.

Your move!

At Greenfish, we would like to draw the attention to show companies that they need to prepare for possible future changes in policies related to climate change. We believe voluntary carbon pricing is a proven instrument which could help forecast and speed up regulations, therefore putting your company ahead of these upcoming requirements.

Furthermore, it will allow companies to transform risks into opportunities and largely help them in their decarbonisation efforts. But, as CDP warned, corporate transparency about your ICP systems is also a key parameter. Indeed, investors will still need detailed knowledge of the companies’ ICP systems to fully understand how effective the carbon prices are within the decision-making process. Finally, a rational and realistic vision for internal pricing of carbon will be to raise the price over time, apply it to emissions across the value chain, and embed it within operational as well as capital spending. So, when do we start?

Florian Deveza – Junior Environmental Consultant at Greenfish
Quentin Lancrenon – Project Analyst at Greenfish
Nassim Daoudi – Managing Director at Greenfish

 

[1] World Bank Group & Ecofys, 2016. Carbon Pricing Watch 2016, s.l.: s.n.

[2] An international non-profit that drives companies and governments to reduce their greenhouse gas emissions that works with institutional investors with assets of US$100 trillion

[3] CDP, 2017. Putting a price on carbon. Integrating climate risk into business planning., s.l.: s.n.

[4] I4CE & EpE, 2016. Internal carbon pricing, A growing corporate practice, s.l.: s.n.