Carbon pricing has found favour in a significant and ever-increasing number of national and regional jurisdictions. As of April 2023, there were 73 schemes either in force, under development or under consideration (1). Its popularity among policymakers can be understood, in part, due to its market-based approach and, also, by its revenue-raising potential. In 2022, global carbon pricing revenues reached almost USD$100bn, driven by a combination of the introduction of new carbon-pricing initiatives and increasing prices in existing markets.
What does carbon pricing achieve?
Carbon pricing captures some of the external costs of emissions, which are otherwise paid for by the public in damages to, for example, crops, property or healthcare costs, and mandates that the producer of the emissions pays for them. A carbon price thereby shifts the burden for climate-related damages to those who are responsible for them.
Instead of dictating who should reduce emissions where and how, a carbon price provides an economic signal to emitters. This allows emitters to decide to either transform their activities and lower their emissions or continue emitting and pay the price assigned to their emissions. As a market-based tool, it acts as a strong economic incentive for individuals and businesses to reduce emissions and switch to cleaner, low-carbon alternatives.
What are the societal impacts of carbon pricing?
Carbon pricing has a number of potential societal impacts, depending on how it is implemented. It imposes a cost on economic activities that may lead to social discontentment and unrest, as witnessed in France by the gilets jaunes demonstrations of 2018 onwards in response to a planned rise in the tax on diesel and petrol intended to aid the transition to greener fuels. It also risks organisations moving their emitting economic activities to a jurisdiction with lower, or no, taxation with a resulting loss of employment in the country imposing the carbon-price scheme, known as carbon leakage. Scheme design and policy implements, such as a Carbon Border Adjustment Mechanism (CBAM), can help to address these concerns.
What is internal carbon pricing?
Carbon-pricing schemes can be broken out into government-mandated compliance markets and those where participation is voluntary, such as carbon-offset market and internal carbon pricing (ICP). A strategic approach to managing policy risk not only involves an understanding of how compliance carbon pricing may impact a business but also embeds ICP throughout the organisation.
ICP is a mechanism that companies are increasingly using to assess, guide and manage GHG emission-related risks and opportunities (2). It aims to realign decision making in a way that factors in the costs and value that may arise from the transition to a low-carbon economy. ICP assigns a value per tonne of GHG emissions to calculate the cost of carbon at a company level. This cost value is then factored into the decision-making process when calculating the capital cost of a project or investment, helping to incentivise behaviour that lowers GHGs. The design of the ICP will impact how the scheme operates: whether the price will remain a hypothetical accounting tool – ‘internal shadow price’ – or will actually be levied on a business unit – ‘internal carbon tax’.
Why should businesses consider implementing internal carbon pricing?
ICP schemes are key tools that can help business leaders to deepen their understanding of their exposure to the true cost of carbon within their business. Once this is understood, the priority should shift towards how a company can act to minimise this exposure. Implementing ICP schemes requires an understanding of what an individual business wishes to use the scheme for. Internal shadow prices can offer a vital window into the hypothetical costs associated with a business’ operations. Based on these prices, business decisions and investments can be well-informed and remain mindful of the emissions throughout the business’ value chain.
Internal carbon taxes, on the other hand, can be used to directly fund decarbonisation initiatives and change the emissions attached to a business. Internal carbon pricing schemes can be used as a toolkit by businesses to explore their exposure to emissions-related costs, with the ultimate aim of driving change in mindset or operations throughout a business.
There are tangible benefits to implementing ICP. Taking this action can help organisations to realise the carbon cost of decision making and improve their sustainable performance to position themselves as leaders, rather than laggards, among their peers.
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(1) World Bank. 2023. State and Trends of Carbon Pricing 2023. Washington, DC: World Bank. doi: 10.1596/978-1-4648-2006-9. License: Creative Commons Attribution CC BY 3.0 IGO
(2) World Bank. 2023. State and Trends of Carbon Pricing 2023. Washington, DC: World Bank.