In a global economy with a constantly growing concern for climate change, an unlikely approach is gaining traction with corporate leaders for its ability to uncover smart, cost-effective investment choices.
Internal carbon pricing – a self-imposed 'eco-tax' companies place on their carbon emissions. Picture it like this: companies are setting up a 'pollution jar.' Each time they generate carbon emissions, they are required to contribute funds to this jar.
By doing this, businesses voluntarily impose a cost on their carbon emissions, turning their attention toward improving their practices to reduce these emissions. It's a smart move where the cost of polluting becomes a powerful incentive for sustainability.
This approach has a considerable effect when executives realize that these internal carbon prices can directly impact their performance metrics and the company's overall success. Let’s delve deeper into how this strategy encourages emission reductions and fosters sustainable business practices.
The value of internal carbon price strategies
Companies exposed to climate markets realized that voluntarily placing a price on carbon helped them assess the financial impact of their emission reduction targets.
In a turbulent economic climate, traditional investment and procurement approaches may leave a business with stranded or underperforming assets. Internal carbon pricing drives a more comprehensive method rooted in understanding a company’s energy and emissions flows.
It is important to highlight: this strategy works best for companies that proactively manage their energy costs and have multiple sites. Carbon dioxide emissions are largely a by-product of the combustion of fossil fuels for energy production. An organization’s energy usage works in tandem with the amount of carbon emissions they produce, so understanding energy is required to understand and manage carbon.
As an example, suppose a natural gas boiler needs replacement. Traditional capital or maintenance decisions would simply replace the worn-out boiler with another boiler. On the other hand, internal carbon pricing considers the environmental cost of another boiler in addition to the operational impacts and can draw attention to alternatives such as air source heat pumps. Not only are heat pumps cost competitive and lower emitting, but they also have the added flexibility of being able to cool building spaces and heat them. The result? An internal carbon price can incentivize a better capital replacement tactic than simply replacing incumbent technology.
As more and more companies electrify to reduce their Scope 1 emissions, higher electricity costs or power shortages are limiting many companies’ ability to maintain production or expand operations.
An internal carbon price, however, can improve the case for installing on-site power solutions such as solar, combined heat and power and geothermal heating. These technologies can be deployed more quickly and efficiently, while also requiring a lower cost, than any new transmission line meant to deliver power from a distant centralized source.
Two ways to set up an internal carbon price
Essentially, companies have two ways to set up an internal carbon price. A hypothetical “shadow carbon price” and an “internal fee”. A shadow carbon price evaluates the risk associated with a project at a specific range of potential carbon prices. An internal fee sets an actual carbon price which is applied to the actual carbon emissions for which each business unit is responsible.
Either option becomes a lens through which investment and operational decisions are made. A trusted energy or carbon advisor can provide invaluable advice in setting up such mechanisms.
Executives should adopt internal carbon pricing as a tool to speed up activity and demonstrate to their key stakeholders, such as clients and shareholders, that they are reducing their climate change impacts and associated regulatory risks. Internal carbon prices anticipate potential business disruptions and promote innovation.
Companies are finding that pricing carbon can motivate employee buy-in for energy conservation, efficiency improvements and waste reduction. Asking suppliers to disclose the embedded carbon emissions in their products strengthens the market choices for innovative, clean technologies.
Despite these benefits, most companies do not yet see the relevance of an internal carbon pricing strategy. I am confident this attitude will quickly change.
New disclosure requirements in 2024
Beginning in January 2024, Canadian financial institutions will be required to disclose climate-related emissions in their portfolios. Banks will ask their corporate borrowers, as a condition of their loan or credit facility, to report their carbon dioxide emissions. Nearly every business in Canada will be exposed to carbon emissions disclosure requirements.
Businesses have only a matter of months to determine and report their carbon dioxide emissions, and once that hurdle has been crossed, an internal carbon price will be much easier to implement. Finance teams should be speaking to their lenders now to understand and prepare for these changes.
Some banks are going further than asking customers to simply disclose climate-related risks. They are developing pathways to drive those risks out of their lending portfolios; 'sustainability-linked loans' is one such channel.
Sustainability-linked loans offer business customers lower interest rates if those borrowers reduce the carbon emissions intensity of their operations. Borrowers wanting to take advantage of these loans will discover that internal carbon pricing can help them drive down their corporate carbon dioxide emissions.
Business executives can only determine and disclose carbon emissions if they understand how energy is used in their operations. Focusing on climate-related disclosures and internal carbon pricing can help drive improvements to Canada’s competitiveness, incentivizing long overdue productivity improvements and the long-term, sustainable prosperity of Canadian businesses.