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A survey conducted by CDP cited that over 2,000 companies were either using internal carbon pricing or plan to enact one within two years © FT Montage/Getty Images

Among the reasons governments give for not introducing carbon taxes designed to reduce emissions is that they can be politically tough to impose. However, in the absence of such levies, some companies are doing it themselves: by putting their own price on the emissions generated by their operations.

Internal carbon pricing can serve several purposes. It can both incentivise and raise awareness of the need for carbon reduction. It can also assist in strategic planning — by enabling companies to compare the relative profitability of different investments if a national carbon tax were imposed.

“Adding a carbon cost that can be cascaded down to the departments making those decisions makes the carbon, and financial, consequences more tangible,” says Shane Hughes, director of corporate net zero services at engineering consultancy Ramboll.

It is a tool that has become more popular in recent years. More than 2,000 of almost 6,000 companies surveyed in 2020 by CDP, the environmental disclosure non-profit, said they were either using an internal carbon price or planning to implement one within the next two years.

Shane Hughes

“To survive as a business in the future, you have to engage in global business planning,” says Amir Sokolowski, global director of CDP’s climate change team. “And one of the methods of doing that is knowing what your risks and opportunities are. This helps you identify them.”

Companies using internal carbon pricing are essentially putting a monetary value on the carbon they emit through their operations. However, while that sounds relatively simple, the way carbon pricing tools are implemented varies considerably, as do the prices and objectives set by the companies using them.

In one model, setting an “implicit price” enables companies to use retroactive calculations to evaluate the investments they need to make to meet their climate-related targets. “That’s looking back at what has actually been spent on reduction efforts to date, whether to mitigate or offset emissions,” explains Sokolowski.

Another model — “internal trading” — is rather like government-run cap-and-trade systems. Companies can allocate carbon credits to different business units, which can sell those credits to other units if they exceed their emissions reduction targets.

Meanwhile, some companies charge business units a “carbon fee”, with a set monetary value designed to incentivise emissions reduction initiatives, such as energy efficiency, while generating funds that can pay for renewable energy supplies or carbon offsets.

At Microsoft, for example, the internal carbon fee the company introduced in 2012 helps fund purchases of renewable energy and sustainable aviation fuel, as well as carbon removal initiatives such as forestry, direct air capture, and carbon sequestration projects.

Most popular, according to CDP is “shadow pricing”, with more than 60 per cent of CDP respondents saying they use this tool. Under “shadow pricing”, a hypothetical price per ton of carbon emissions is set and, while no actual payments are made, it informs strategic decisions on future investments.

Laura Draucker, director of corporate climate action at Ceres, the sustainable investor network, cites the example of companies with large real estate assets having to consider what capital investments to make on heating systems — bearing in mind factors such as future regulation, or the cost of energy.

“You might apply a proxy price to ensure you’re not making a decision that could be cheaper on paper today, but in a few years would be more expensive,” she explains. “That’s potentially most useful for making larger decisions.”

However, if tools such as carbon fees are used only to buy carbon credits, the risk is that they simply push companies’ climate obligations down the road. “One of the biggest failures we see with the use of internal carbon pricing is the assumption that it’s just a finance department function designed to generate funds to buy offsets,” says Hughes.

And, while it is relatively simple to impose a carbon fee on things like business travel, for many companies their own operations represent a fraction of their carbon footprint. Most of it is generated in supply chain operations, which are far harder to control.

“That highlights the limitation of internal carbon prices,” says Draucker. “They’re easiest to impose on things that for most companies aren’t their biggest emission sources or their biggest climate risks.”

She sees internal carbon pricing as useful in helping kick off a climate strategy, in culture change and in strategic planning — but stresses that it needs to be part of a broader carbon reduction strategy.

“It’s a tool with some uses,” Draucker says. “But companies that are really serious about thriving in a decarbonised economy are going to need to do much more than impose internal carbon taxes.”

Hughes agrees. “Internal carbon pricing can have its advantages,” he says. “But it is not a silver bullet.”

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