Internal Carbon Pricing: What, Why, and How
Carbon pricing is the process of assigning a price per ton of greenhouse gas emissions which helps to capture the external cost of GHG emissions. This external cost can then be tied back to the source of the emissions and the party responsible can be held accountable, rather than leaving the public to pay the price. Ultimately, carbon pricing is a method to help further decarbonization efforts. Carbon prices are typically set by governments or markets; however, many businesses are beginning to take matters into their own hands with internal carbon pricing.
Internal carbon pricing (ICP) is a tool used to reflect the social, environmental, and economic costs of climate change on financial decisions. More and more companies are setting their own carbon prices with the goal of mitigating risk, reducing their carbon footprint, and preparing for future regulations. By establishing ICP, companies can highlight carbon-intensive activities within their operations and incentivize decisions aligned with emissions reductions.
Common reasons that companies are implementing carbon pricing include:
- Driving Low-Carbon Investment
- Engaging Employees
- Driving Energy Efficiency
- Guiding Capital Investment Decisions
- Achieving GHG reduction Targets
- Gaining Competitive Advantage
- Scenario and Transition Risk Analysis
- Preparing for Regulations
So, you're interested in ICP, but how does it work? Below we outline seven steps to help you get started with your own internal carbon pricing strategy.
7 Steps to Implement Internal Carbon Pricing
1. Allocate Accountability
The first step is to assign accountability: who is in charge of what and how can they contribute to the overall GHG reduction targets? Before implementing ICP, your organization should already have calculated baseline GHG emissions and have set ambitious emissions reduction targets that align with science. Allocating accountability will help to ensure that everyone is in agreement with the goals set and that your strategies for achieving the goals are in alignment.
2. Gain Internal Buy-In
From the start of a company’s climate commitment journey, it is key to engage stakeholders from across the company. Successfully implementing ICP requires strategic decisions about carbon emissions, revenue, incentives, and pricing structure which means buy-in from across the company will be necessary to make progress toward your goals. Key internal stakeholder can include:
- Sustainability Team
- Senior leadership
- Finance
- Enterprise Risk Management
- HR employees accountable for Change Management and Employee Training
- Supply Chain / Procurement
- IT
3. Determine the Scope
A crucial step to implementing ICP is to clearly define the objectives and scope of the strategy. Determine which business activities will be included in the IPC mechanism. To be successful, you much find the right balance between impact, difficulty, and influence. To do this, ask yourself the following questions:
- Impact: what is the potential positive impact that influencing the business activity will have on achieving the company’s GHG target?
- Difficulty: how difficult it is to calculate the emissions of each option considered in the decision point?
- Influence: how much emissions can potentially be influenced by the decision maker?
4. Select an Approach
There are four methods of implementing internal carbon pricing: carbon charges, shadow prices, internal cap and trade, and implicit carbon pricing.
The most common types of internal carbon pricing mechanisms are carbon charges and shadow pricing. Both send a price signal by assigning a monetary value to greenhouse gas emissions, but carbon fees collect revenue whereas a shadow price does not. Shadow pricing was the most common type of internal carbon price reported to CDP in 2020 and 2021.
Internal cap and trade is an approach with an upper limit on total emissions from all business activities. A company creates an allowance for each ton of carbon emitted, and various business units within the organization can buy, sell or trade any excess allowances with each other.
An implicit carbon price is an approach where the carbon price is calculated based on how much it costs a company to implement emissions reduction projects, such as renewable energy purchases or energy-efficiency upgrades. An implicit price is calculated retroactively after a company reduces emissions.
5. Set a Price
A good place to start is with the UN Global Compact’s recommended price of $100 / MT and adjust up or down based on internal and external factors specific to your organization. Important factors to consider include:
- The Social Cost of Carbon: A financial estimate of the economic damages that would result from emitting an additional ton of carbon dioxide into the atmosphere
- Carbon Pricing Regulations: This consideration accounts for carbon tax rates and emissions trading schemes (ETS).
- Carbon Price Corridors: Scenario analyses that identify the carbon price range required to meet a 1.5-degree outcome.
- Behavior Change Incentives: The minimum price needed to encourage innovation, unlock investment, and shift market signals to reduce greenhouse gas emissions.
- Cost of Offsets: A 2022 report from Ernst & Young on the carbon credits market states the average current price at $25/tonne and expects that price to rise to $80-150/tonne by 2035.
- Investments Needed: Companies can calculate this price by dividing annual funding required for emissions reduction initiatives by annual GHG emissions in scope of the pricing mechanism.
6. Pilot and Implement
As with any new initiative, running a pilot prior to full implementation will allow you to test the strategy, gather feedback, fix any bugs, and make improvements. With the lessons learned from your pilot, you’re ready to fully implement ICP across your operations.
7. Measure
Perhaps the most important step is to measure the effectiveness of your program. It’s critical to regularly assess whether the ICP initiative is supporting desired outcomes for the business, outcomes for people, and business capabilities.
Remember, implementing internal carbon pricing into your strategy is not the end goal. Rather it is just one tool to implement in your overall carbon reduction strategy.
Is Internal Carbon Pricing Right for Your Business?
Now that you have a better understanding of what goes into setting up an internal carbon pricing strategy, it’s time to decide if it’s right for your business.
Internal carbon pricing should be just one element of your overall strategy to achieve your GHG targets and mitigate climate risks. Consider your organization's unique challenges and objectives and how ICP might help (or hinder) your progress. Consider
- What benefits will the business see, such as mitigating risk (legal, reputational, supply continuity) and capturing business value (brand value, product differentiation)?
- What will be the improvements for affected people?
- What abilities will the company gain from implementing ICP?
- What deliverables will be completed?
- What tasks need to be completed? Each action should be assigned to a person and given a timeline – assign accountability!
- What financial, human, and material resources are required?
If you do implement internal carbon pricing, revisit these questions when measuring progress to help determine if your program is having the intended effect.
The Beverage Industry Environmental Roundtable (BIER), in collaboration with Antea Group, recently published “Internal Carbon Pricing: An Implementation Guide for Beverage Companies.” This guide offers a detailed analysis of internal carbon pricing and implementation by coalescing public research and case studies in consultation with BIER members.
This toolkit offers a better understanding of how Internal Carbon Pricing (ICP) can be a useful tool in a company's decarbonization journey.
To learn more about internal carbon pricing and other decarbonization strategies, connect with our Sustainability Team!
