Carbon Pricing: A Case for Transformative Climate Action

The following was published Nov. 7, 2017 on the World Bank’s Carbon Pricing Leadership Coalition blog. Read original post here.

Carbon pricing – in the form of a carbon tax or an emissions trading system – has become a tool increasingly used by governments to address climate change. There’s also growing momentum in the private sector. The latest C2ES report, “The Business of Pricing Carbon,” finds that companies across sectors and geographies are increasingly adopting internal carbon pricing as one tool to prepare for the business-related physical and transition risks of climate change and take advantage of the opportunities in a low-carbon future. As an indicator of this trend rising on the corporate agenda, as of 2017, almost 1,400 companies disclosed to the CDP that they are currently using an internal carbon price or plan to do so in the following two years.

By putting a financial metric on a company’s greenhouse gas emissions, carbon pricing sends a price signal that incentivizes behavioral change and makes the business case to shift investments toward low-carbon options.

Companies take different approaches to internally price their carbon emissions:

A carbon fee: a monetary value on each ton of emissions charged to business unit(s), creating a dedicated source of revenue or investment stream to fund projects that help meet a company’s greenhouse gas reduction targets. For example, in recent years, Microsoft and the Walt Disney Company have applied an internal carbon fee of $5-$10 per ton and $10-$20 per ton, respectively.

A shadow price: a theoretical value used by companies in project planning processes to test the profitability of future investments and R&D expenditure in anticipation of future carbon regulations. BHP uses a shadow price of $24-$80 per ton to shift investments toward low-carbon options and increase the robustness of its portfolio. Other approaches used by companies include implicit carbon pricing, or a hybrid of these approaches.

Through company disclosures to the CDP and interviews with 20 global Fortune 500 companies, the C2ES report shows that internal carbon pricing can have multiple benefits, including: advancing a company’s greenhouse gas reduction goals, preparing for future carbon regulations, responding to stakeholder demand for climate-risk disclosure, creating resilient supply chains, building a competitive advantage, and showcasing corporate responsibility.

Future proofing their companies against government carbon regulations is one of the greatest motivations for many companies adopting an internal carbon price—especially those using a shadow price.

How Does Corporate Carbon Pricing Link with The Conclusions from The Report from The High-Level Commission on Carbon Prices?

The High-Level Commission on Carbon Prices, co-chaired by economists Joseph Stiglitz and Lord Nicholas Stern recommends that a regulatory carbon price of at least $40-$80 per ton by 2020 and $50-$100 per ton by 2030 will be required to stay well below the 2C degree target. The commission’s objective is to identify corridors of carbon prices to guide design of government carbon pricing instruments and policies to implement the Paris Agreement and advance the Sustainable Development Goals.

While the Commission’s recommendations are meant to guide explicit government policies and regulations, the observed shadow pricing levels across many companies are also consistent with them.

Take the case of the energy sector where major global oil and gas companies operating in regulated jurisdictions apply a shadow price ranging from $27.92-$80 per ton. BP and Shell for example, each apply a shadow price of $40 per ton.

Beyond the oil and gas sector, the health, nutrition, and materials company, Royal DSM uses a shadow price of $55.84 per ton, exceeding the price of the European Union’s Emissions Trading Scheme that it trades in. Some companies operating in jurisdictions that do not have an explicit government carbon price are adopting shadow pricing levels that are also in line with the Commission’s recommendations.

For example, the Indian multinational automotive and farm equipment company, Mahindra & Mahindra, Ltd.  plans to introduce a shadow price of $50 per ton to meet its long-term goal of carbon neutrality, respond to existing national policies that embed a carbon price (e.g. a tax on fossil fuels), and to prepare for potential explicit carbon regulations at the national level.

So, what do the commission’s recommendations mean for transformative climate action?

  • At present, three-quarters of the global emissions covered by government carbon pricing are priced below US$10 per ton, a price economists say is not high enough to incentivize behavioral change and climate action necessary to achieve the Paris target of well below 2 degrees C. The Commission’s recommendations can drive transformative action in the following ways:
  • Provide clarity and long-term certainty to companies that their investments in low-carbon options will provide a greater rate of return over carbon-intensive ones and that will be at a competitive advantage in a future where carbon is priced at higher levels.
  • Most companies (especially the ones using shadow pricing) set their internal carbon prices using future climate policies and regulations as a key input. The recommendations serve as a benchmark to companies determining internal carbon prices to make strategic investment decisions.
  • As more and more companies adopt internal carbon prices in line with the commission, it signals to governments that companies are supportive of carbon pricing and will be ready to respond to explicit and higher carbon regulations when expanded to their jurisdictions.
  • The commission’s guidance can help governments design bold climate policies as a part of their NDCs that can put countries on a low-carbon trajectory.
  • In light of the Taskforce on Climate-related Financial Disclosures (TCFD), as more and more companies adopt carbon pricing consistent with commissions’ recommendations, it would reassure investors that their investment portfolio will be profitable in a carbon-constrained future and that their portfolio of companies are adequately managing climate-related risks.

 How can companies implement the Commission’s recommendations?

Initially, more sector specific guidance is needed. The Carbon Pricing Corridors Initiative launched by the CDP and We Mean Business in 2017, is an important step in this direction. In May 2017, the initiative launched the world’s first investment-grade carbon pricing for the power sector, reporting that utilities would need a carbon price of $35-$100 per ton by 2030 to limit global warming to 2 C. In the next two years, the initiative plans to provide initial carbon price ranges for other energy-intensive sectors including steel, cement, paper and pulp, and aluminum. This guidance will be useful for companies and investors seeking to transition to a low-carbon future and using carbon pricing to take transformative climate action.