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Here or there?
Where to set an internal carbon price?
Along with scope 1, 2 and 3 emissions, percentage of assets at risk, and several other metrics, Climate Reporting Entities under the Aotearoa New Zealand Climate Standards must disclose the price per metric tonne of CO2e they are using internally. The Taskforce on Climate-related Financial Disclosures (TCFD) defines an ‘internal emissions/carbon price’ as:
“An internally developed estimated cost of carbon emissions, which can be used as a planning tool to help identify revenue opportunities and risks, as an incentive to drive energy efficiencies to reduce costs, and to guide capital investment decisions.”
Pricing carbon isn’t new
At least not for governments, who have been assigning monetary values to greenhouse gases (GHGs) for decades to help engineer policy outcomes. Cap and trade systems, like the Emissions Trading Scheme, and carbon taxes are examples of explicit carbon pricing. More commonly, governments price carbon implicitly through subsidies on things like solar panels and EVs, or through product efficiency standards, congestion charges, and even fossil fuel subsidies.
For companies, however, the practice of pricing emissions is in its infancy. But it’s growing quickly. Of the roughly 6000 companies that provided carbon disclosures to CDP in 2020, about 2000 say they either price carbon emissions or plan to do so within two years.
And with countries around the world mandating the recommendations of the TCFD, or something similar (like we did here in Aotearoa), it’s a safe bet that this trend will accelerate.
What is XRB trying to achieve here?
Fewer emissions, less risk, and more opportunities. Our words, not theirs.
When companies price emissions they are incentivised to reduce them. The cost-benefit calculus changes in favour of lower-carbon projects, processes and assets, which reduces companies’ exposure to external carbon prices, drives the uptake of innovative technologies and practices, and ultimately reduces the release of GHGs along the value chain. Well-considered emissions pricing is a handy strategic tool that helps companies navigate the seismic transition to a low-carbon world.
How to price carbon?
In short, a company’s emissions should be priced in relation to what the company is trying to achieve.
Of course, there is a strong argument for pricing emissions according to their costs. This ‘social cost of carbon’ (SCC) puts a dollar value on the total damage caused from emitting one tonne of CO2e. In principle, internalising negative externalities has merit – why shouldn’t I pay for the true cost of the activities from which I profit? In practice, SCC prices are very hard to agree on and most likely underestimate the cost by a significant margin. Therefore, paying the true cost of a business’s activities would often make that business uneconomical overnight…but that’s a discussion for another time.
Why not peg our internal emissions price to authoritative projections, like those provided by the government? That would certainly add some credibility. But which should you choose? The government’s auction reserve price, which will be $60 NZD as of December this year. Or its upper cost containment trigger price of $216? Alternatively you might be guided by the ‘shadow price of carbon’ developed by the government’s interagency group, whose central predictions hit $174 NZD by 2050. Perhaps you’ll align your internal emissions price within the band recommended by The High-Level Commission on Carbon Prices (HLCCP) to meet the Paris Agreement temperature targets, which is roughly between $90 and $160 NZD by 2030.
While the variation in these projections isn’t ideal if you’re looking for a single authoritative anchor for internal emissions pricing, we should note that they weren’t developed for the same purpose. The government’s ETS reserve and trigger prices provide stability to emissions prices in the regulated market, while the interagency shadow price and the HLCCP band guides economic and policy analysis.
The same logic applies to companies setting internal emissions prices: the price depends on what the company wants to achieve with it. A few examples:
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Your company anticipates that the carbon intensity of its exports will soon be considered by foreign market regulators. So, you set a high shadow price and integrate it into product development planning to help surface potential lower-carbon options.
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Your company’s direct (scope 1) emissions are low but critical stakeholders are raising concerns about the downstream emissions released by it’s products. You hold off on pricing direct emissions and establish a moderate carbon fee that ring- fences money for the exploration of downstream decarbonisation.
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Your company has set ambitious emission reduction targets but it’s not clear which aspects of the business should be prioritised. You set a shadow price recommended by an industry body and use it to help identify the most effective reduction opportunities.
To get a sense of just how varied internal emissions pricing can be, have a look at the 2021 sectorial distribution data from CDP.
It’s not just about the price
In the simplified examples earlier, you probably noticed that the price is just one of the relevant dimensions that companies should consider when developing an internal emissions pricing program. We also need to determine things like:
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Which sources of emissions we want to price: all of them within our organisational boundary, or just scope 1?
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How we want to structure the price: incur a fee and embed it into our OPEX or just monitor the price passively with a ‘shadow price’?
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Decide over what time period the pricing is used: until we’ve met our carbon reduction targets?
The Carbon Pricing Unlocked partnership put together a useful guide to help companies with this, and they break down internal emissions pricing into four dimensions
Developing guidelines and/or policies for how the internal emissions price will be deployed in practice and testing them internally is essential. For example, if we ringfence the proceeds from an internal emission price to be spent on decarbonisation projects, does this mean we can spend that money on consultants to help identify options? Or can we only take money from the pool if it’s spent on new equipment or processes?
Perhaps most importantly, an emissions pricing program needs to have the support of leadership behind it; as well as support and understanding across the company and its departments.
This sounds like a lot. Is it worth the effort?
Implementing a fully-fledged internal emissions price can certainly be a big undertaking. And CREs have a lot on their plates at the moment as they get up to speed with all the other requirements of the Aotearoa New Zealand Climate Standards. For starters, companies need to calculate their emissions before an emissions price becomes useful.
However, it’s worth emphasising that internal emissions pricing is a very practical and very effective tool for strategic decision-making. It’s also not a totally different beast from the other metrics that XRB wants us to disclose. Rather, internal emissions pricing can directly inform and help evaluate climate-related risks and opportunities.
While internal emissions pricing needn’t be conquered by tomorrow, it’s certainly worth thinking about the role it could play in helping your company prepare for the future.
Cover photo by Elimende Inagella on Unsplash