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11 Aug INSIGHTS | Internal Carbon Price: an Innovative Strategy for Sustainable Growth
An internal carbon price is an instrument used by entities such as companies and financial institutions to incentivize climate action by assigning monetary value to carbon emissions. The financial cost of carbon emissions is often invisible yet substantial. Nations are beginning to factor the social cost of carbon, that is the economic cost of total climate damage on society, into cost-benefit analyses to inform policy decisions. Private sector entities also rely on cost-benefit analyses to make sound business decisions. A well-implemented internal carbon price may reveal financial risks and opportunities related to carbon emissions, driving improvements in energy efficiency, supply chain management, and resilience to regulatory changes (such as carbon tax and environmental laws). For companies, investment managers, and any organizations with a sustainability agenda, internal carbon pricing can be adopted as an innovative method to generate positive change within the organization.
Types of internal carbon price
There are two types of carbon prices: shadow prices and carbon charges. Shadow prices concretize the risks of carbon emissions in monetary value for direct application in investment decision-making. As the name suggests, shadow prices do not involve actual payments, but serve as an additional metric to quantify climate-related risks in business assessments.
Carbon charges, on the other hand, can be interpreted as a voluntarily applied internal tax in an organization for every ton of greenhouse gas emitted. The organization may assign a baseline emission for each participating unit and charges based on any emissions above the baseline. An organization may choose to implement an internal carbon price as either shadow prices, carbon charges, or a combination of both.
Shadow prices are not actually collected, while carbon charges are collected by a designated entity within the organization. Depending on the organization’s policy, the collected carbon charges may be earmarked for emission reduction activities only, such as energy efficiency upgrades and carbon offset, or act as an additional fund for unrestricted use. As a principle, the use of funds should always encourage continued decarbonization. For example, the organization may explore innovative uses of its collected carbon charges, such as awarding the funds to its most energy-efficient departments or units, thereby creating healthy internal competition to incentivize sustainable practices.
How to determine an internal carbon price
Deciding on an effective internal carbon price requires careful consideration. If the carbon price is too high, the business may be heavily burdened by the extra cost and the merit of the program will be jeopardized by internal opposition. On the other hand, too low of a carbon price is insufficient to create any meaningful behavioral changes, as business units may prefer paying a small cost instead of spending time and effort on lowering their carbon emissions.
When setting an internal carbon price, the entity can reference the location-specific estimate of the social cost of carbon published by research institutions, environmental agencies, or governments. The United States government estimated the social cost of carbon in 2020 to be USD51 per ton of carbon dioxide equivalent (CO2e). This cost is expected to rise to USD62 by 2030 and USD85 by 2050. For entities that mainly use a shadow price to mitigate regulatory risks, an expected future carbon price in its local carbon market can be a good benchmark.
If such an estimate is not available, or a customized internal carbon price is preferred, then the entity should fully understand its carbon reduction target and pathway. This involves doing carbon inventory on current and previous emissions from each business unit, then setting a practical and ambitious carbon reduction target (such as net zero) with a detailed implementation timeline. The internal carbon price can then be adjusted based on each year’s actual emissions relative to the reduction goal of that year, helping the entity stay on track to reach its decarbonization goal.
Case Studies of Internal Carbon Prices
Temasek Holdings (Singapore)
Singaporean investment company Temasek has implemented an internal carbon price of USD50 per ton of CO2e as a shadow price in 2022. This carbon price has been lifted from the previous USD42 in 2021 and is likely to rise as climate change further affects the economy in the future. At Temasek, the internal carbon price is applied to investment evaluation to account for an investment’s potential exposure to climate transition risks and directly affects the approval of the investment. As a result, high-emitting entities, such as those involved in red meat production, were screened out due to low financial return after the application of internal carbon prices. The implementation of a shadow carbon price also complements Temasek’s overall sustainability strategy to direct financing towards climate change mitigation projects and decarbonization solutions.
Yale University (USA)
In addition to corporations and financial institutions, various types of organizations can also leverage internal carbon pricing to boost decarbonization. In 2014, Yale University became the first university to experiment with internal carbon pricing. The initiative began with a one-year pilot program in which a USD40 per ton of CO2e was applied to emissions from the energy usage of twenty campus buildings as a carbon charge. The pilot study proved the positive potential of internal carbon pricing for university campuses to drive down emissions in a cost-effective way.
In the 2018 fiscal year, Yale officially implemented carbon charges into organizational budgets for 264 out of its over 400 campus buildings, hence covering more than 70% of Yale’s carbon emissions. Each school or other top-level administrative unit was charged for every ton of emission from its buildings. In 2021, the university committed to achieving zero actual greenhouse gas emissions from its campus by 2050. As the university estimates a 4-5 times increase in annual investment required to fulfill this commitment, all revenues from Yale’s carbon charge program are earmarked for emission reduction projects. Yale’s internal carbon price currently stands at USD20 per ton of CO2e and will increase to USD35 in the 2024 fiscal year and USD50 in the 2025 fiscal year. The university will also re-evaluate this rate as the social cost of carbon evolves.