Implementing carbon accounting, climate disclosure, and integrated reporting standards into a business’s core and financial planning ultimately contributes to one goal: establishing an internal cost of carbon. Why? Because it guides the reallocation of capital to finance decarbonization initiatives. While historically an externalized expense, assigning an internal cost to each metric ton (tonne) of emitted CO2e translates climate change and climate impact into financial terms, providing a clear value to companies and stakeholders beyond risk management.
What is internal carbon pricing?
Establishing a cost for carbon within your organization ensures that the cost to operate and ultimately emit greenhouse gasses is accounted for on the balance sheet. This enables a clear cost-benefit analysis for decarbonization, as there is an existing cost to operate and emit, viewed against an investment cost to decarbonize. In short, it’s difficult to justify capital expenditures and investments in emissions reduction without assigning a cost.
Assigning a cost to carbon
To begin assigning an internal price for carbon, companies need to first understand their total emissions. Accounting for a company’s total emissions provides a look at the opportunities for emissions reduction and lays the foundation for goal setting. Once a company’s goals are clear, companies can set a price per metric ton of CO2e, applying this price across operations to generate the necessary funds to implement decarbonization initiatives or otherwise cover the fees for continuing to emit high amounts of greenhouse gasses. Carbon pricing is a highly effective strategy for measuring and reducing exposure to market risks and government-mandated emissions limits.
Regulatory landscape for carbon pricing
Carbon pricing is becoming more common as a catalyst for companies to address climate risk and reduce emissions. Globally, pricing mechanisms are recognized as a critical tool for realizing the 2016 Paris Agreement's goals. Article 6 specifically facilitates international cooperation on carbon pricing strategies, highlighting the role of pricing carbon in global efforts to reduce emissions and transition to a low-carbon economy.
Governments and regulatory bodies are intensifying their focus on carbon emissions, with mechanisms such as emissions trading systems (ETS) and carbon taxes becoming more prevalent. The World Bank’s Partnership for Market Readiness (PMR) and the International Carbon Action Partnership (ICAP)'s Emissions Trading in Practice: Handbook on Design and Implementation provides a comprehensive, 10-step process for policymakers to design an ETS. The process proves that iterative, systematic, and thoughtfully-implemented carbon pricing mechanisms like ETS and carbon tariffs are a powerful tools for financing innovation and operational improvements that drive progress toward net-zero carbon emissions. The EU’s Carbon Border Adjustment Mechanism (CBAM), an import tariff on carbon-intensive materials entering the EU, is meant “to encourage cleaner industrial production in non-EU countries,” with similar efforts taking place in Canada.
In the U.S., the Biden administration’s social cost of carbon metric, previously restored to $51 per metric ton, has been updated to nearly four times that at $190 per ton. This metric is used in rule making and permitting processes to calculate economic damages associated with a rise in emissions, impacting investment decisions across emissions-intensive industries.
As programs like the EU’s CBAM and others take shape, it’s becoming increasingly common for companies to assign internal costs for emissions. With so many policies and regulatory schemes incorporating a per-tonne price on CO2e emissions in various states of development and implementation, self-imposing an internal carbon price is a logical way to get a head start on compliance and best position your capex strategy against transitional risks.
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Companies are already prioritizing internal carbon pricing strategies
Assigning a consistent financial value to carbon emissions helps to level the economic playing field by justifying capital expenditures in decarbonization initiatives. This helps to address the “green premium,” or the additional costs typically associated with decarbonization.
Companies proactively adopting internal carbon pricing mechanisms are equipping themselves to avoid potential financial impacts from forthcoming regulations. Between 2015 and 2021, the number of companies using or planning to implement internal carbon pricing increased by 8%, according to CDP, with nearly half of the 500 largest companies factoring internal carbon costs into their business and financial planning globally. Take Microsoft and Swiss Re, for instance. Both have successfully implemented internal carbon pricing models, turning carbon costs into opportunities for innovation and financial savings.
Microsoft has been a pioneer, using its internal carbon fee to drive down greenhouse gas emissions while funding sustainable tech innovations. Since 2012, this strategy has not only helped Microsoft reduce its carbon footprint, largely through the purchase of over 10 billion kWh of clean energy that reduced emissions by 7.5 million mtCO2e, it also saved the company more than $10 million annually by investing in energy efficiency and green power.
The reinsurance company, Swiss Re, implemented an internal cost of $100 USD (called its Carbon Steering Levy) per tonne in scope 1-3, a price that escalates over time and encourages continuous improvement in carbon management across all operational scopes. It will gradually increase to $200 USD per tonne in 2030 (it was $112 in 2022). The funds generated are invested in carbon removal technologies and ecological restoration projects, directly linking financial expenditures to environmental impact and aligning economic incentives with climate goals.
Assigning an internal cost of carbon to future-proof your business
Assigning and accounting for an internal cost of carbon is not just about mitigating risks—it’s a forward-looking strategy for financial planning. Companies that embrace this approach can align their operations with global climate goals, thus securing a competitive edge in a future where environmental considerations are likely to dictate market dynamics.
As seen with Microsoft, Swiss Re, and many other companies, integrating an internal carbon price into financial planning supports global decarbonization efforts and drives corporate growth, profitability, and resilience.
By establishing a carbon price, companies can set aside funds for decarbonization projects, turning what would otherwise be regulatory costs into strategic investments that drive progress toward net-zero GHG emissions. Companies should carefully consider the evolving regulatory and market environments to ensure their carbon pricing strategies are both compliant and strategically advantageous.
Sources
1. World Bank Group, “What You Need to Know About Article 6 of the Paris Agreement,” https://www.worldbank.org/en/news/feature/2022/05/17/what-you-need-to-know-about-article-6-of-the-paris-agreement Accessed June 13, 2024
2. World Bank Group, “What is Carbon Pricing,” https://carbonpricingdashboard.worldbank.org/what-carbon-pricing Accessed June 13, 2024
3. Open Knowledge Repository, “Emissions Trading in Practice, Second Edition: A Handbook on Design and Implementation,” https://openknowledge.worldbank.org/handle/10986/35413 Accessed June 13, 2024
4. Chartered Professional Accountants Canada, “What the border carbon adjustment will mean for business – a primer,” https://www.cpacanada.ca/public-interest/public-policy-government-relations/policy-advocacy/climate-change-sustainability/border-carbon-adjustment-primer Accessed June 13, 2024
5. Reuters, “Biden 'social cost of carbon' climate risk measure upheld by U.S. appeals court,” https://www.reuters.com/markets/commodities/biden-social-cost-carbon-climate-risk-measure-upheld-by-us-appeals-court-2022-10-21/ Accessed June 13, 2024
6. The New York Times, “Biden Administration Unleashes Powerful Regulatory Tool Aimed at Climate,” https://www.nytimes.com/2023/12/02/climate/biden-social-cost-carbon-climate-change.html Accessed June 13, 2024
7. CDP, “Nearly half of world’s biggest companies factoring cost of carbon into business plans,” https://www.cdp.net/en/articles/media/nearly-half-of-worlds-biggest-companies-factoring-cost-of-carbon-into-business-plans Accessed June 13, 2024
8. Microsoft, “How Microsoft is using an internal carbon fee to reach its carbon negative goal,” https://www.microsoft.com/en-us/industry/blog/sustainability/2022/03/24/how-microsoft-is-using-an-internal-carbon-fee-to-reach-its-carbon-negative-goal/ Accessed June 13, 2024
9. Swiss Re, “Swiss Re announces ambitious climate targets; accelerates race to net zero,” https://www.swissre.com/media/press-release/nr-20210316-swiss-re-announces-ambitious-climate-targets.html Accessed June 13, 2024
10. Swiss re, “The CO2NetZero Programme,” https://www.swissre.com/sustainability/sustainable-operations/co2netzero-programme.html Accessed June 13, 2024
