Internal Carbon Pricing: A Strategic Approach to Boost Climate Transition Within Organizations

Climate Change, SDGs, and the Role of Companies

The phenomenon of climate change represents one of the greatest challenges of our era. Human activities, such as the burning of fossil fuels and deforestation, have significantly increased concentrations of greenhouse gases (GHGs) in the atmosphere. These GHGs, such as carbon dioxide (CO2) and methane (CH4), act as thermal blankets, trapping the sun’s heat and causing an increase in the average temperature of the planet. This phenomenon, known as global warming, results in a series of negative impacts, such as melting polar ice caps, rising sea levels, extreme weather events, and loss of biodiversity.

In its 2030 Agenda for Sustainable Development, the United Nations sets a specific goal – SDG (Sustainable Development Goal) 13 – to combat climate change and its impacts through actions that promote mitigation and adaptation to climate change. Reducing GHG emissions is a fundamental pillar for achieving this goal. Understanding and addressing the challenges related to climate change not only contributes to the preservation of the environment but also to the pursuit of sustainable and equitable development, ensuring a better quality of life for present and future generations.

In addition to the crucial responsibility of governments in developing public policies, companies play a fundamental role in climate action and GHG reduction. Understanding and responding to the challenges of climate change is not only a social responsibility but also a strategic necessity for companies. Growing public awareness, consumer demands for sustainable products and services, as well as investor pressure for the adoption of responsible business practices, are driving organizations to take concrete measures to reduce their GHG emissions. Furthermore, companies that position themselves as leaders in mitigating climate change have the opportunity to gain a competitive advantage by promoting innovation, operational efficiency, resource savings, and resilience to climate-related risks.

As part of their efforts to promote effective climate action, companies have been using a wide range of tools and innovative approaches. Among them, the implementation of Internal Carbon Pricing (ICP) stands out. In this article, we will explore how the implementation of ICP can help companies achieve a successful climate transition, providing an overview of the steps involved and highlighting the expected benefits and outcomes.

Internal Carbon Pricing as a Tool for Climate Action

Internal carbon pricing refers to a mechanism used by companies to assign a monetary value to the greenhouse gas (GHG) emissions generated by their activities. It is an internal approach that establishes a price for carbon within the company, regardless of government policies or regulations on the subject.

The adoption of this mechanism brings a series of benefits to companies that adopt it, including:

• Incentive for emissions reduction: By assigning a monetary value to carbon emissions, internal carbon pricing creates economic incentives for reducing these emissions. Companies are motivated to adopt more sustainable practices, implement low-carbon technologies, and improve energy efficiency. This helps to reduce the company’s carbon footprint and contributes to mitigating climate change.

• Risk management: Internal carbon pricing allows companies to anticipate future costs associated with climate regulations and policies. This helps in managing financial risks related to climate change, as companies can prepare for a more stringent and uncertain regulatory environment. It also enhances business resilience by considering the risks associated with carbon emissions and the impacts of climate change on their operations and supply chains.

• Competitive advantage: Companies that adopt internal carbon pricing and efficiently reduce their emissions can position themselves as leaders in the fight against climate change. This action demonstrates a commitment to sustainability and can improve the company’s reputation, attracting conscious consumers and climate-conscious investors, as well as leading to the creation of new business opportunities in a low-carbon economy.

• Cost reduction and energy efficiency: Internal carbon pricing incentivizes the pursuit of solutions that reduce emissions and improve energy efficiency. This can lead to a reduction in operating costs, such as decreased energy consumption and optimization of production processes. By identifying energy efficiency opportunities, companies can save financial resources and become more competitive.

• Alignment with global policies and goals: The adoption of internal carbon pricing helps companies align their strategies and actions with global policies and goals for mitigating climate change. This includes fulfilling commitments established in the Paris Agreement and supporting the United Nations Sustainable Development Goals (SDGs). Demonstrating effective commitment to reducing carbon emissions contributes to building a sustainable and resilient future.

The adoption of internal carbon pricing mechanisms by companies has accelerated around the world in recent years. According to data from CDP, one of the largest global platforms for disclosing corporate climate information, currently more than 1,000 organizations already use internal carbon pricing mechanisms, and another 1,600 organizations have plans to adopt an ICP in the next two years. In Brazil, industry-leading companies such as Votorantim Cimentos, Vale, Klabin, and Braskem already adopt one or more forms of ICP.

Functioning of pricing mechanisms

In general, there are three forms of internal carbon pricing: shadow price, internal tax, and internal carbon market. Let’s see what defines each approach:

• Shadow Price: Often used in cost-benefit analysis and decision-making related to capital allocation, the shadow price represents the marginal cost of emission abatement for the company and is used to evaluate new investments or initiatives to reduce emissions.

• Internal Tax: In this modality, companies establish a monetary tax per ton of carbon emission, applied to all their operations. This tax is used to calculate the cost of carbon emissions and can be incorporated into the costs of products, services, or projects. It encourages the reduction of internal emissions, as departments and business units are encouraged to find ways to decrease their impacts and avoid additional costs.

• Internal Carbon Market: In this model, companies create an internal market for the trading of carbon credits. Business units that manage to reduce their emissions below their targets can sell the surplus credits to other units that did not achieve their targets. This creates an economic incentive for emission reduction, as more efficient units can generate revenue by selling carbon credits, while units with high emissions face additional costs to acquire the necessary credits.

Companies can apply one or more of these forms of pricing depending on the objectives they seek to achieve with internal carbon pricing. Unilever, for example, uses both a shadow price approach and an internal carbon tax approach within the organization. More details below.

A incorporação bem-sucedida de mecanismos de precificação de carbono passa, de maneira geral, por um processo de quatro etapas sequenciais. Abaixo, detalhamos cada uma destas etapas

1. Leadership engagement and objective setting: Successful ICP implementation requires engagement from top management and different areas of the company. It is essential to ensure that everyone understands the need for and benefits of ICP. Additionally, it is important to establish clear ICP objectives aligned with climate goals and the company’s overall strategy. These objectives can guide investment decisions, drive low-carbon project execution, and identify current emission sources, subsidizing mitigation strategies.
   
2. Approach and pricing method definition: A crucial aspect of ICP is defining the approach and pricing method. This includes determining the price approach to be adopted, such as shadow price, internal fee, or internal carbon market. Additionally, it is necessary to specify the coverage of GHG emissions, covering scopes 1, 2, and 3. Another important point is establishing the ICP’s influence level on company decisions. Finally, it is necessary to define pricing elements, such as price level, considering options like single vs. distinct and static vs. dynamic pricing.
   
3. Pilot execution and roll-out planning: A recommended approach is to test ICP through pilot projects in the organization. This allows identifying necessary adjustments and evaluating ICP effectiveness in controlled scenarios. Based on pilot results, the roll-out across the organization can be planned, ensuring leadership engagement and providing adequate training and support for involved employees.
   
4. Performance monitoring and management: Once implemented, it is essential to monitor ICP implementation and evaluate its performance. This can be done through key performance indicators (KPIs), such as the percentage of emission reduction, achieved price level, number of decisions influenced by ICP, and changes in project revenue and/or costs. Continuous monitoring allows assessing progress against objectives defined in stage 1 and taking corrective actions if necessary. Finally, it is important to validate whether ICP execution efficiently achieved the strategic objectives defined in stage 1.

Conclusion

Throughout this article, we have explored the importance of internal carbon pricing (ICP) as a strategic tool for greenhouse gas (GHG) emissions management and successful climate transition. Recapping the main points discussed, we highlighted the challenge of climate change and the need for GHG reduction, along with the relevance of ICP as an effective approach to addressing this challenge. We discussed how leadership engagement, clear objective setting, pricing approach, pilot execution, performance monitoring, and evaluation are key elements in successful ICP implementation. Additionally, we emphasized the benefits of ICP for companies, including cost reduction, risk management, reputation improvement, and innovation promotion.

In summary, ICP plays a fundamental role in sustainable carbon emission management, driving companies to adopt more responsible practices and contributing to the creation of a low-carbon future resilient to climate change. It is essential for companies to recognize the strategic importance of ICP and incorporate it into their operations to achieve a more sustainable economy and a healthier planet for future generations.