Set an Internal Carbon Price
Environmental Defense Fund
Setting an internal carbon price (ICP) can help your company account for the cost of greenhouse gas (GHG) emissions and demonstrate commitment to reducing its carbon footprint. ICPs can be integrated into decision-making processes and used to charge business units, with the generated revenue driving emission reductions. Various approaches and prices exist for determining the appropriate ICP, tailored to your company’s emissions reduction goals and future investments.
Internal carbon pricing is a tool to account for the cost of greenhouse gas (GHG) emissions in business planning and investment decisions. It is a price that you can assign to emissions, based on either the actual or estimated cost of those emissions. This price is then used as a basis for decision-making across the business, including operations, investments, and strategy groups.
|Imagine your company is selecting new office space and has narrowed the choice down to two buildings in the downtown area. One is slightly more expensive, but more energy efficient, which will result in lower monthly costs. The other costs less, but is less efficient, so its monthly costs are likely to be higher. The team responsible for selecting this new office space ran an analysis of these two options and found that, without an ICP, the net present value is lowest for the cheaper, less efficient building. You share with the team that ICPs need to be included investment decisions and re-run the analysis with this additional information. Now the more efficient building is the logical choice.|
There are a few different approaches you can use to set an ICP. The right approach for your company should align to your emissions goals and help steer future investments to meet your long-term emissions targets, such as net zero. A number of different approaches, and prices, are possible, and there is no one way to determine the correct ICP for your company.
How to Set an Internal Carbon Price
There are several approaches that you can take when setting an internal carbon price. Some of the most common and effective approaches are discussed below. In addition to these, you can also consider whether the ICP should be uniform across your operations, or if it should change based on geography, jurisdiction, or the public price of carbon markets.
This approach uses publicly available carbon pricing data to determine the cost of your company’s emissions. You can then apply this price internally to your operations. For example, if your company is located in a jurisdiction with a carbon tax, you can use that tax value to determine the ICP.
This approach involves estimating the cost of carbon emissions by analyzing the costs associated with reducing emissions. This can include the cost of renewable energy, carbon offsetting, or carbon capture and storage. Once the costs have been estimated, you can assign a hypothetical price to emissions based on these costs.
For instance, if your company invests in renewable energy to replace its use of fossil fuels, you can calculate the difference in cost between the two types of energy. You can then use this information to assign a price for your company’s emissions.
Social Cost of Carbon Pricing
The social cost of carbon refers to the actual cost of the negative impacts that carbon emissions have on the environment, human health, and society. These impacts include air pollution, sea-level rise, extreme weather events, and health problems to name a few. In other words, it’s the cost of the damage caused by carbon emissions to the environment and people. Though the U.S. government currently (in 2022-23) uses $51 per metric ton of CO2 as a social cost of carbon, the EPA has proposed to increase that number to $185.1 This figure is likely to increase in the future as the impacts of climate change become more severe and the costs associated with mitigating those impacts rise.
Your company can use this figure for its ICP to help it understand the full cost of emissions and the impact they have on the environment and society. Using the social cost of carbon can help companies take responsibility for their carbon footprint and encourages them to invest in more sustainable practices.
Sometimes a hybrid pricing approach may also make sense. For example, if your company operates in some jurisdictions with market pricing, you can include that information in a shadow pricing approach where relevant.
When setting an internal carbon price, it is important to consider not just the least expensive way to internalize the impact of your emissions, but also the implications of those emissions. The social cost of carbon has significant social justice implications and applying that approach can help your company address its impact on disadvantaged communities. Finally, keep in mind that the ICP is not static; it should be regularly reviewed and updated to reflect any changes in the external environment, such as changes in carbon pricing policies.