Internal Carbon Pricing
One way companies are preparing for the net zero transition and the risks and opportunities associated with carbon markets is by setting an internal carbon price. This involves factoring in a price of carbon to business decisions separate from any compliance obligation. Internal carbon pricing is a single measure that can be implemented across the company, simplifying investment decisions and supporting management and boardroom decision making.
Supporting business decision making
Internal carbon pricing can be used to inform decision making in the following ways:
- To support decisions about capital investments (For example, a business might apply an internal carbon price when building new offices. Without an internal carbon price, gas heating and high-carbon materials may appear to be cheaper, but once an internal carbon price has been factored in, lower carbon options are likely to become more attractive.)
- To measure, model and manage the risks posed by (mandatory) compliance carbon pricing regimes.
- To help surface potential new opportunities – for example, identifying innovative products or suppliers that will deliver the most for the business with a lower carbon footprint.
Furthermore, transition planning (where companies develop and implement a plan for delivering on net zero targets and pledges), is increasingly on the radar for many companies. In the UK, for example, under existing law and regulation, UK-listed companies and most other UK-registered companies and LLPs with more than 500 employees are expected to make climate-related disclosures in line with the recommendations of the global Taskforce on Climate-related Financial Disclosures (TCFD). Transition planning requires delivering a strategic vision across the company, and internal carbon pricing can support this, helping to drive management decision making.
Setting a price
A higher internal carbon price may drive deeper transformation more quickly. Businesses could look to the High-Level Commission on Carbon Pricing’s recommendations ($40-$80 rising to $50-$100) when setting their own price. Not only has this price range been estimated to effectively reduce emissions, but following these guidelines will make businesses resilient to changes in compliance carbon pricing, which may follow the same recommendations.
Company boards, and specifically the Audit Committee, will want to consider whether to report on the carbon price they have chosen, and their reasons for doing so.
Businesses with an adequate internal carbon price should not face the same disruption from policy changes. By encouraging a shift towards sustainable alternatives across a business’ operations, an internal carbon price can also minimise the impact of other climate policies including industrial standards and technical regulations, giving businesses a competitive advantage over others who are less prepared, and helping to future proof business operations.
Internal carbon pricing mechanisms
The carbon price used by businesses is often hypothetical and used as a performance indicator across the business (known as a shadow price).
However, businesses can also go a step further and actually impose an internal carbon fee. This strategy involves using the internal carbon price to calculate an amount that is paid into a central fund. Such funds have typically been put towards sustainability projects. Microsoft, for example, prices carbon determined by the total cost of the carbon fee fund investment strategy, which is set to meet the organizational carbon reduction policy.
It is also possible for companies to set up an internal market to trade emissions allowances, in a way that mirrors jurisdictional emissions trading schemes.
Stakeholder engagement
Increasingly, investors are considering climate risk. Companies that have adopted an internal carbon price and showcase their forward approach can attract more sustainable investment.
Engaging in carbon pricing can enhance relationships with stakeholders, including customers, suppliers, employees, and shareholders by demonstrating corporate leadership in sustainability.
On the board, the audit committee has responsibility for overseeing the integrity of narrative reporting, including on sustainability matters, and reviewing any significant reporting judgements. It is therefore responsible for deciding whether a company should report openly to stakeholders on its internal carbon price. It should be noted that the TCFD recommends disclosing a carbon price where used.