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Carbon Pricing: A Path to Resilient Recovery

Contributed By: Elena Cernov, Sustainability Consultant, Schneider Electric Energy & Sustainability Services

Businesses, investors, NGO’s and governments are seizing the opportunity to use their recovery from COVID-19 as a chance to build a sustainable, inclusive economy.

The recent drop in emissions due to COVID lockdowns is most likely short-lived, but the realization of how quickly environments can recover from even temporary drops in emissions is inspiring companies around the world to pursue a resilient recovery. Massive programs of green public investment to revive virus-hit economies, promoted publicly by the IMF, are likely to fuel the trend.

Among the many resilient recovery investments and strategies companies have at their disposal, carbon pricing is among the most impactful commitments to consider.

What is internal carbon pricing?

Setting an internal price on carbon has the potential to energize the post-lockdown resilient recovery and ensure decision-making processes are oriented to a less carbon intensive future. Internal carbon pricing is a tool developed to address and prepare companies for the upcoming short- and long-term carbon shift. It is an internally developed estimated cost of carbon emissions and is used as a pricing mechanism to inform a company’s decision-making processes in various ways depending on the final goal.

Carbon pricing can take two forms:

  • Shadow price - a hypothetical cost of carbon applied to each ton of CO2, included in cost calculations as a passive indicator. This practice reveals hidden risks and opportunities throughout operations and supply chain and allows decision makers to take this adjusted price into consideration when deciding on budget and potential investments.
  • Internal fee – an internally used carbon tax on the emitted CO2 where the collected money is usually reinvested in energy-efficiency projects, transitions to greener company practices, etc.

How do companies use internal carbon pricing?

Depending on the geographical context, type of activity of the company, dependency on resources and local legal requirements, companies choose to use internal carbon pricing with quite different goals in mind. Here are several publicly available examples of how carbon pricing takes shape in different organizations:

  1. Identify revenue opportunities and enhance competitiveness

RUSAL set an internal carbon price at $20 per ton. Should the cost make a project unprofitable, RUSAL will either find a low-carbon alternative to make the project more profitable or reject it altogether.

  1. Guide capital investment decisions

Saint Gobain uses two levels of prices. The first one, 30€ per ton, is applied to the most substantial investments such as the construction of a new plant or energy-related projects on existing plants. This tool has already had tangible decision-making effects. For example, the company chose gas in place of coal to power a new plant in a developing country. Without this high internal price of carbon, coal would have been the choice.

In 2012, Microsoft established an internal carbon tax at $8/per ton of CO2 emissions, and used the proceeds from the fund to invest in renewable energy, community projects that offset carbon, and new climate and energy technologies. In 2019, The company nearly doubled its carbon price to maintain their carbon neutrality and to put sustainability at the core of every part of the business and technology.

  1. Monitor and adapt their strategies and financial planning to real-time and potential future shifts in external market

Saint Gobain’s second carbon price, which is much higher (100€ per ton), is used to guide R&D budgets with a long-term orientation, further than 2030.

  1. Make low carbon transition an integral part of the business strategy.

In 2018, Heineken piloted its internal carbon pricing scheme in the context of setting Science Based Targets.

  1. Prepare for the policy shifts and potential loss of currently applicable exemption on carbon costs

Seven Generations Canada, as an upstream oil and gas producer, is exempt from carbon levy until 2023 but is adopting a shadow price of carbon that reflects the escalating levy into project economics. This activity is critical to the company’s forward planning and investments

  1. Fee used to fund investments in various carbon reducing initiatives

Ben & Jerry’s company is using an internal carbon fee to fund investments in their suppliers – where their largest carbon impacts are. That means focusing on their value chain, specifically their dairy farms, which represent the largest source of the company’s GHG emissions.

These are just a few ways of using carbon pricing, and each company has its own twist in how to adapt it to its own goals and values. It is certainly a tool that can be adopted by companies in order to make sure they are prepared to account for their emissions but also that they are prepared for a future which is emission-unfriendly.

How to get started?

Accounting for carbon costs in long-term planning today is key for preparing industries for a future that will surely have more requirements. But the transition to using one in daily decision-making can be complex.

As one of the first major companies to set and successfully use a carbon fee to drive sustainable outcomes, Microsoft released a playbook designed to guide other companies in the ‘what, why and how’ of setting a carbon price. The guide includes 5 actionable steps to establishing an internal carbon fee at any company. To help European companies along this transition, the European Commission launched a targeted consultation as part of its Renewed Sustainable Finance Action that closed on July 15, 2020. The results of the consultation will affect the requirements of disclosing climate related information in a context of recovery, including indicators like internal carbon pricing.

There is also research on Carbon Price Risk Premium lead by Trucost, part of S&P Dow Jones Indices, which represents the gap between current carbon prices and future carbon prices. The analysis points out how the financial risk from carbon pricing schemes will depend on variables like carbon efficiency of the company, location of operations, business model and strategy and sectoral market conditions. Moreover, there are carbon pricing corridors, developed by CDP and We Mean business, as sector specific benchmarks for businesses and investors seeking to make strategic decisions consistent with a low-carbon economy.

As a starting point for companies interested to set an internal carbon price, we suggest determining what approach and for what goal a company would like to use an internal carbon price. Then, map the processes that are most affected by carbon prices now. Through scenario analysis, identify sectors that might be affected in the near and far future. Using the results of the above steps, companies should be able to determine the price level and internal governance that will work for their individual organization.

Considering the price of carbon in internal decisions shouldn’t be a progressive vision or experimental approach—carbon emissions do and will continue to have a real cost and not counting that in decision making will affect the resilience of certain business decisions. Our experts can help guide you through any step of analysis and liaise internal communication on deciding the right strategy of “Building Back Better”. Contact us today get started.