Zero in on... Internal carbon pricing

Internal carbon pricing incentivises carbon cutting by placing either a hypothetical (shadow) or actual cost on emissions. Using this as a performance indicator can steer your business towards decisions that support your climate ambitions.

Applying a hypothetical carbon price is a common approach to ICP, but you can also choose to charge business units an actual fee for their emissions. This money can be placed in a fund and used as a sustainable piggy bank, for example, to offset emissions or finance carbon reduction projects.

ICP can help manage climate risk and identify opportunities in your operations and supply chain. It is used to better understand the potential impact of external carbon pricing on the profitability of new projects, service lines and products, business models or investments.

You can use internal carbon pricing in three key ways:

1. To inform decisions about capital investments (especially when projects directly affect emissions, energy efficiency, or changes in the portfolio of energy sources).
2. To measure, model and manage the financial and regulatory risks posed by existing and potential Government carbon pricing regimes.
3. To help identify risks relating to missing net zero targets by not fully understanding the operational cost of carbon transition interventions. As well as opportunities like identifying innovating products, services, business partners and suppliers that can help the business grow and build resilience while reducing emissions.

The ICP can be tailored to support the unique business needs and net zero transition aims of organisations. As a result, the price ranges used to cost carbon are highly variable. Choosing the right carbon price depends largely on the level of your ambition, what you are trying to achieve, and the challenges you are likely to face.

Common options include:

Uniform price: A single price used throughout your organisation, which according to results published by CDP, is adopted by most disclosing companies.

Differentiated price: This may vary depending on geographic location, business unit or decision type, taking into account the specific needs of each.

Evolutionary price: This adjusts and evolves over time, based on a number of factors including the projected cost of carbon, voluntary market supply and demand, and other business and/or industry specific considerations.

Once you identify how you can use ICP, decide whether to go for a hypothetical or actual price. Consider what type of business decisions you are likely to inform with an ICP, and how you are likely to apply it. The price you set tends to decide the degree of influence it will have across your business. After all, higher carbon prices usually lead to deeper cuts in emissions and more rapid business transformation.

If you’re interested in launching an ICP to support your net zero journey, key steps to prepare your business include:

1. Identifying the business decisions that could benefit from the ICP
2. Assessing the feasibility with your internal stakeholders
3. Developing your approach (set the price and create a framework for appraisal of capital investments)
4. Communicating this across the business
5. Monitoring and evaluating the ICP approach

If you want to get started on ICP, try using this ‘Zero in on’ as a discussion point with colleagues, especially if your organisation already has an ESG working group that brings different teams together. Picking a few simple areas to explore first is usually an easy way to start building momentum.