December 13, 2023
Internal Carbon Pricing

What an organisation does has long lasting negative effects on the environment and society. For the longest time there was no way to keep organisations in check or foster the sense of accountability towards the stakeholders on the receiving end of the negative impacts. But now, we can put a price on emissions, making this a way towards making companies responsible for their actions. As the economy expands, the emissions are also rising. Climate change has evolved from being a myth to our reality. Thus it is essential to start taking measures to reduce the emission of greenhouse gases (GHGs).

What is Carbon Pricing?

The cost of the damages caused by emissions made by businesses to society in the form of damage to health, property, environment, etc, can be summed and can be charged on the company. This can be seen as the price on the CO2 that the business emits. This measure ensures that the source of these emissions is held accountable, and instead of repairing the damages caused, it ensures that the emissions itself can be reduced. This will happen because companies will have to choose whether to cut the emissions down or pay the price later. This will incentivise more sustainable and green development and we can finally takes steps to achieving various environmental goals. As businesses will have some mandatory emissions, these prices will help them analyse the impact of the emissions on their operations. Governments use the carbon pricing mechanism in their policies and can even use it as a source of revenue. Investors use carbon pricing to analyse and compare potential investments and project portfolios, ensuring that they promote climate resilient activities and sustainable development.

There are different types of carbon pricing tools that can be used. The emission trade system (ETS) is a great example of the same, where one can trade emission units. The Results-Based Climate Finance is also a mechanism where funds are allocate to projects where the outputs such as reduction in emissions are already defined.

What is Internal Carbon Pricing?

As mentioned earlier, companies need to get a better understanding of how their emissions will affect not just the environment and society, but also their own business. To make financial and operational decisions, it is important to keep a buffer for the cost of their CO2 emissions. Internal Carbon Pricing is thus a cost that is applied by the business itself on their own GHG emissions. This helps them make better more prudent business decisions. There are four categories under the Internal Carbon Pricing tool (according to the UN Economic and Social Commission for Asia and the Pacific (UNESCAP)). They are:

  • Shadow Pricing: This is the system of putting a hypothetical price on the emissions caused by the company. This helps in assess project emissions in way that can also show the profitability of the same.
  • Implicit Pricing: This measures the cost of emissions after emission abatement is achieved in existing projects. These prices can also be set based on the carbon offsets purchased.
  • Internal carbon tax/fees: These charges re applied on company-wide emissions. This ensures that all departments are held accountable for the emissions they produce, and will have to try to reduce it to reduce the costs. The revenue that is generated fro this will then be used to fund low-carbon projects.
  • Internal trading mechanisms: Drawing from the ETS, this gives each department in the organisations carbon credits which can be traded between them. There is also a cap on the total carbon credits, making sure that the emissions are within a certain limit and each department is held accountable.

Internal Carbon Pricing is a win-win situation for everyone. Companies that adopt internal carbon pricing structures get a holistic view of their operations and their impacts. It helps them make better decisions in terms of budgeting and mitigating climate change. This also generates funds for sustainable projects and proofs them of any climate or policy related risks. Governments use this to gauge the social cost of carbon emissions. Financial institutions and investors use these carbon prices to analyse portfolios. Ultimately, society and the environment are also benefiting from the reduction of emissions and all the damage caused by it.

But how do companies decide the price of their emissions? Depending on the type of pricing (as discussed earlier), companies can determine the costs.

  • For shadow pricing, external published sources can be linked to it. This ensures that your prices are up to date with the internal carbon pricing systems.
  • For implicit pricing, the cost is determined by how much is spent on efforts to reduce the GHG emissions.
  • For carbon taxes or fees, an internal customised carbon price for the company should be made. This should be calculated with the issues and dynamics of the company kept in mind, and reviewed frequently to ensure that the prices are up to date.

Some companies are required to adopt internal carbon pricing due to regulations. However, many companies have done this without any requirements by regulations or authorities. This is because they have realised the need to be resilient to climate change and be prepared for any changes in policy or the environment. Internal carbon pricing provides companies with a mechanism to be self-sufficient and accountable for its own actions. This way, companies can truly contribute to the reduction in emissions and help combat climate change.

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