Setting an Internal Carbon Value on One Ton – A Complex but Necessary Step

By Olivia Fussell

Companies that are building in a price for carbon in their financial forecasts will be better prepared to manage the transition as more climate change reporting, risk and regulation become an evident business cost globally. The need for a company to account for the cost is becoming a necessary step and is considered fiscally responsible, particularly for industry sectors, such as oil and gas.

Corporate leaders know that anticipation and planning around the inevitable expenses relating to carbon emissions is a necessary exercise. The recognition of this trend is documented in an April 2021 CDP Report, based on responses by over 5,900 corporate disclosures in 2020. The latest data is showing an 80% increase in the number of companies planning or using an internal carbon price since 2017, when the last report was published. CDP reports that almost 50% of the largest companies by market cap are putting a price on carbon or planning this action in the next two years.

A key finding from the CDP report notes that internal carbon pricing goes hand in hand with emission reduction activities, such as setting science-based targets, sourcing more energy from renewables, energy efficiency measures, and purchasing carbon offsets. Companies can use internal carbon pricing for a number of reasons, including changing corporate behavior. This drives low carbon initiatives such as transportation and managing many levels of risk.

Internal carbon pricing creates an estimated cost per ton of carbon emissions. As the Gold Standard describes clearly; it is used to better understand the future impact of external carbon pricing on the profitability of a project, an investment, or a new business model.

The benefits of this approach include a way to narrow the business risks against future carbon pricing legislation. Setting a price on carbon does enable companies to test and assess the profitability of lower carbon projects and resources in different scenarios and different geographies. This important forecasting exercise can stimulate technological innovation and investments into these projects.

Using an internal or shadow price on carbon can demonstrate to a company’s investors that it understands the exposure to future regulations. CDP reported that 5 in 10 companies disclosed the use of a shadow price in 2020 that covered their direct (scope 1) emissions. CDP’s analysis found that the median carbon price (global) was $25 per metric ton of CO2e. A closer look at the data does show that thresholds (upper and lower) vary quite widely by region and industry. In Europe, the median is $27 per metric ton, Asia is $18. Companies are selecting values that are the most useful and comprehensive within their own business sectors and regions.

A note that the price rose considerably a month ago in the EU trading scheme to $44.80 per ton. It’s obvious that the median corporate internal carbon price needs to go higher to cover carbon emission costs in the future against existing and pending regulations. 1,113 companies disclosed to CDP that they are subject to carbon regulations that include the EU Emissions Trading Systems (ETS), Japan’s carbon tax, Korean national ETS, California Cap and Trade, and South Africa’s carbon tax.

Carbon taxes are a direct levy from a national or regional government that differs from an ETS. A tax differs in that it can provide a higher level of certainty on cost, but less on the reductions that will be achieved. The oil, gas, and power sectors report the highest expectations on regulations while apparel and hospitality the lowest. CDP reported that over 3,000 companies disclosed that they do not consider they will need to face government regulation on the price of emissions within three years and therefore do not see it as a great risk to their investors or consumers.

Seeking the optimum internal carbon price is the holy grail and attempts to help companies identify the range is happening more and more, but its complexity can be intense. Putting a price on societal and environmental externalities from the impact of climate change is also part of the financial and risk equation for companies. It’s an evolving discipline and prices and procedures are often not disclosed.

Source:

CDP, ‘Putting a Price on Carbon: The State of Internal Carbon Pricing by Corporates Globally’, April 2021. Nicolette Bartlett, Tom Coleman, Stephen Schmidt, available here.