Getting a grip on decarbonization with effective internal carbon pricing

GETTING A GRIP ON DECARBONIZATION WITH EFFECTIVE INTERNAL CARBON PRICING

Introduction

Regulators and stakeholders are increasingly pressuring organizations to monitor, improve, and share information on their greenhouse gas (GHG) emissions. With the rise in carbon pricing initiatives globally, organizations must better manage and steer their carbon footprint by implementing internal carbon pricing (ICP).

Key Drivers for Decarbonization

1. Regulatory Mechanisms: Many governments have implemented carbon-pricing mechanisms like carbon taxes, cap-and-trade systems, and the EU's Carbon Border Adjustment Mechanism (CBAM). New regulations such as the EU Corporate Sustainability Reporting Directive (CSRD) and the International Sustainability Standards Board (ISSB) S1 and S2 standards require companies to disclose their GHG emissions across scopes.
2. Market-Driven Mechanisms: Consumers, investors, and business partners are increasingly demanding reduced emissions, leading companies to better manage their own emissions and those of their supply chains.
3. Legal Challenges: Companies have faced legal actions for environmental damage and non-compliance with public emission reduction commitments. For example, Shell was ordered to reduce its CO2 emissions by 45% by 2030.
4. Voluntary Initiatives: Many companies have set internal targets or joined programs like the Science Based Targets initiative (SBTi) or RE100.

How Internal Carbon Pricing Works

An internal carbon price (ICP) is a financial cost assigned to emissions, integrated into investment and procurement decisions. It helps in evaluating the net present value (NPV) of projects and decisions, enabling more informed and sustainable choices. While ICP is currently voluntary, upcoming regulations like the European Sustainability Reporting Standards (ESRS) and IFRS S2 may require its use.

Challenges to Implementing ICP

1. Reliable Data: Calculating realistic carbon prices requires accurate data on emissions from all scopes (1, 2, and 3). This can be challenging due to the complexity of supply chains and the need for trust in external data.
2. Prioritization: Companies face multiple pressing issues like high energy prices and unstable supply chains, which can make the implementation of ICP seem less urgent.

Steps to Successfully Implement ICP

1. Involve All Key Corporate Functions: Ensure executive leadership, ESG/sustainability teams, procurement, and other departments are involved in setting and using ICP.
2. Start Small and Scale Up: Begin with a comprehensive but manageable approach, focusing initially on major impacts and gradually expanding coverage.
3. Use Estimation Methods: Adopt methods like spend-based, average data, or hybrid models to get an initial understanding of GHG emissions.
4. Prioritize Data Collection: Start with areas that have the largest impact and lower data collection requirements, moving towards more detailed data as needed.
5. Align with Strategy: Develop an ICP that aligns with the company’s overall sustainability strategy to enhance resilience against future regulatory changes.

Conclusion

Implementing ICP is crucial for effective decarbonization. By involving all key corporate functions, starting with reliable data, and prioritizing strategic alignment, organizations can gain greater control over their carbon-reduction strategies and demonstrate transparency and efficiency. Early adoption provides a first-mover advantage and sets a strong foundation for achieving future sustainability targets.