Why Corporations Set Internal Carbon Prices

Editor's note: This is the third article in a three-part series on Corporate Offset Programs. The first piece explored why to purchase offsets; the second piece explored why buyers develop and implement offset programs. This follow-up article examines the role of internal carbon prices.

By Sheldon Zakreski

When companies first began pursuing ways to reduce their carbon footprints, efforts often took the form of a budgeting and activity-based exercise. Companies set a target, allocated a budget, and focused on discrete measures — such as energy efficiency, renewable energy and carbon offset purchases. It was unheard of for a company to place an internal price on carbon.

But businesses are coming to realize that there is strategic value in imposing an internal carbon price. According to the Carbon Disclosure Project (CDP), a global system disclosing the environmental impacts of companies, cities and regions, more than 500 companies reportedly used an internal carbon price last year. This is three times greater than 2014. Keeping the momentum going, another 732 companies reported to the CDP their plans to implement an internal carbon price in 2017 and 2018.

The reported price range is broad, starting at 30 cents and going up to almost $900 per metric ton of carbon dioxide equivalent emissions (mtCO2e). To put this range into context, regulatory programs in North America have carbon prices ranging from $5 to $30 per metric ton, while the U.S. government's current estimate of the social cost of carbon is approximately $40 per metric ton.

Companies are increasingly sophisticated in how they approach this issue -- establishing multiple and dynamic prices that take into account different jurisdictions where they operate, the urgency to lower emissions, and trends in regulatory carbon price levels.

So, what’s driving this trend in corporate carbon pricing?

Assessing the impact of carbon pricing regulation

The World Bank’s most recent State and Trends of Carbon Pricing report observed that several companies in Canada and the U.S. adopted internal prices similar to the compliance prices used in California and the Canadian provinces of Alberta, British Columbia and Quebec. These prices range from $11 to $23.

Indexing internal prices to compliance market prices helps companies to understand how their business can best adapt should they become subject to broad-based carbon pricing regulations.

Inform internal decision-making

Energy companies in particular are notable users of internal carbon prices. For example, both Shell and ExxonMobil integrate carbon prices to understand the future economics of existing and planned oil extraction projects. Exxon assumes a rising price that will reach $80 in 2040. The adoption of dynamic carbon prices allows them to better inform the financial benefits and risks of investing in new projects, which require billions of dollars of capital today.

Risk management

While managing risk is related to the above driver, especially for energy companies, a wide swath of businesses understand that their future stock price value faces climate risk, whether they have a large carbon footprint or not.

Notable examples of companies that aren’t energy-intensive users, but face great exposure to climate change impacts, are reinsurance companies; that is, companies that provide insurance to insurance companies themselves. This industry is susceptible to much risk, given that they must pay policyholders substantial sums of money for damages incurred following extreme weather events.

Many other companies are also beginning to realize the need to take action, as investors increasingly raise concerns about the risks climate change poses to the financial bottom line. When BlackRock, the largest investment firm with $5.1 trillion under management, calls for investors to examine the climate exposure risk of potential investments, companies listen.

Spur innovation

As noted earlier, initial efforts to address a company’s carbon footprint are often focused on discrete activities such as energy efficiency and renewable energy. But as companies address their “low-hanging fruit” opportunities and supplement with offsets, they face the challenge of what to do next to address their emissions. This is where an internal carbon price can help.

Putting a price on emissions helps companies to not only focus on the cost-benefit analysis of different options, but to also better assess how innovative measures can play a role. Renewable energy is an example of how internal prices can help company views evolve regarding which strategies to pursue. Many companies initially purchased renewable energy credits from external projects, however, internal carbon prices can help them to evaluate the merits of developing their own renewables projects — such as biogas=powered server farms for high-tech companies like Google, Microsoft and Facebook, or onsite energy generation technologies like fuel cells.

The adoption of internal carbon prices is a welcome trend that represents not only the increased maturation of companies when it comes to addressing their carbon footprint, but also a clear signal that businesses view widespread carbon price regimes as inevitable. This trend will continue to grow as businesses exhaust the low-hanging fruit options available to them, and increasingly respond to growing investor sentiment that climate change poses a significant financial risk to their bottom line.

Image credit: Flickr/Damien McMahon

Sheldon Zakreski is the Director of Carbon Compliance for The Climate Trust.