ESG Essentials for Corporates: The environmental angle #6 - “Carbonomics” - putting a price on carbon

04 September 2020

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Despite growing attention on clean energy, fossil fuels still account for 80% of global energy consumption and 75% of greenhouse gas emissions.

Needless to say that curtailing the use of fossil fuels is key to achieving the 2050 targets of the Paris Agreement and successfully halting climate change. However, it also presents the biggest challenge.

In this article we take a look at the tools, policies and technologies that can help our economies become less dependent on fossil fuel.

Jargon buster

Paris Agreement: The Paris Agreement marks the most comprehensive and binding climate initiative, instructing all 197 country signatories to put forward their best efforts – the so-called nationally determined contributions (NDCs) –  to keep the global temperature rise this century well below 2oCelsius above pre-industrial levels, and to pursue efforts to limit the temperature increase even further to 1.5oCelsius.

IPCC: The Intergovernmental Panel on Climate Change is a committee of climatologists, meteorologists, geographers and other scientists, established in 1988 by the World Meteorological Organization (WMO) and the United Nations Environment Programme (UNEP) to assess the science related to climate change.

CPLC: The Carbon Pricing Leadership Coalition is a voluntary initiative that brings together governments, business, civil society and academia to support carbon pricing, share experiences and enhance the understanding of carbon pricing implementation.

Putting a price on carbon 

With 2050 fast approaching, the pressure on decarbonising our economies is building further. There is a growing awareness that putting a price on carbon will be a major tool, if not the most important tool to achieve net-zero emissions.

Carbon pricing passes the cost of emitting greenhouse gases (GHGs) on to the emitters. In doing so, carbon pricing changes corporate and public sector decision making, while stimulating technological innovation to bring down the cost of emissions abatement measures. Therefore, carbon pricing has been considered a powerful tool to steer producers and consumers towards low-carbon production processes and products respectively. What’s more, with the generated revenues, governments can invest in low-carbon infrastructure and climate-smart technologies, further stimulating growth and creating jobs to replace those lost in the fossil fuel sector.

Carbon pricing instruments can take many forms:

  • A carbon tax puts a direct price on GHG emissions with emitters having to pay for every ton of carbon pollution. The idea is that the higher price steers businesses and individuals to less carbon-intensive alternatives. A carbon tax is different from an Emissions Trading System (EU ETS) – the emission reduction outcome of a carbon tax is not pre-defined but the carbon price is.
  • A carbon credit system, also known as a cap-and-trade system, sets a limit on total direct GHG emissions from specific sectors, while also creating a market where the rights to emit (allowances) are traded. Firms that cut their pollution faster can sell allowances to companies that pollute more, financially rewarding those moving more quickly towards low-carbon production. Also, governments typically lower the cap over time to increase pressure on businesses to reduce their emissions. The EU carbon credit system, the EU ETS, was the world's first major carbon market and remains the biggest one. It has proved that putting a price on carbon and trading can work: in 2020, emissions from sectors covered by the system will be 21% lower than in 2005. In 2030, emissions from sectors covered by the EU ETS are forecast to fall by 43% from 2005 levels[1].
  • Under a results-based climate finance (RBCF) framework, entities receive funds when they meet pre-defined climate-related goals, such as emissions reductions. RBCF is a newer approach proving popular in developing countries.
  • Internal carbon pricing is based on the idea that governments, businesses and other organisations assign their own internal price to carbon use and factor this into their investment decisions.

Carbon pricing – room for improvements

Christine Lagarde, President of the ECB, has called carbon pricing “the single most effective mitigation tool”[2]. However, to date, carbon pricing has not yet produced the deep emission reductions anticipated at its launch – leading experts to point out the flaws of the system and how these could be overcome.

  • Adjusting the price tag: The global carbon price needs to go up to $75 per ton in 2030 to contain global warming to 2oCelsius, the upper-bound target of the Paris Agreement. This is in stark contrast to the current average carbon price of $2 per ton[3]; with carbon prices varying significantly from less than $1 in Poland to $139 in Sweden[4], and no carbon pricing systems in place in other countries.
  • This has lead to calls for an increase of the geographical and sector coverage of carbon pricing. So far, 57 carbon pricing-initiatives have been implemented, or are scheduled for implementation, across the 186 governments, which ratified the Paris Agreement. 28 of those are emission trading systems (ETSs) and 29 are carbon taxes, primarily applied on a national level. While steadily on the rise, until 2019, these initiatives have only covered about 20% of global GHG emissions. To increase the adoption of carbon pricing, organisations, such as the Carbon Pricing Leadership Coalition, are now focusing on Middle East and North African countries, which are particularly vulnerable to climate change. The Global Carbon Council, the first voluntary carbon-offsetting program in the region, has gathered interest from 20 projects that are developing submissions to use offsets to help countries and organisations achieve their carbon neutrality target[5]. Equally, initiatives are underway to extend carbon pricing to previously excluded sectors such as the agricultural, maritime, and aviation sectors; all heavy GHG emitters. 
  • Pushing the concept of internal carbon pricing: When a company applies an internal carbon price it sets internal emissions targets for divisions or departments and adds a surcharge to any emissions that exceed these limits; this means, in effect, it’s factoring climate-related risks into its business processes, helping to make climate-smart decisions. In 2017, over 1,300 companies, including more than 100 Fortune Global 500 companies, were using some form of internal carbon price to inform their decision-making or were planning to do so in the next two years[6].
  • Use of carbon pricing revenues: Global income from carbon pricing mechanisms has grown from $22 billion in 2016 to $44.6 billion in 2019. While 42% of carbon pricing revenue in 2017/18 was allocated to environmental projects, 11% to development projects, 6% to fund cuts to other taxes, and 3% for direct government transfers to households and businesses, a large chunk of 38% went to the general fiscus[7] rather than being channeled into low-carbon projects, significantly dampening the impact of carbon pricing.

Internal carbon prices for corporates – the new normal

According to CDP almost 1,400 companies were factoring an internal carbon price into their business plans in 2017, a steep eight-fold leap over four years[8].

Multinationals are leading the way with carbon pricing schemes, acknowledging that an internal fee on carbon not only helps to meet emissions reduction targets, but also encourages low-carbon innovations and consequently improves future competitiveness. Some companies have reported that internal carbon prices have affected their budget allocations or the creation of a new business function. It also impacted investments, shifting capital towards energy efficiency measures, and low-carbon initiatives and also impacted on their product offerings.

Companies that commit to an internal carbon price, agree to align with the UN Global Compact’s Business Leadership Criteria on Carbon Pricing:

  • Setting an internal carbon price high enough to materially affect investment decisions to drive down greenhouse gas emissions; the UN Global Compact proposes to seta minimum price of $100 per ton.  
  • Publicly advocating the importance of carbon pricing through policy mechanisms that take into account country-specific economies and policy contexts 
  • Communicating on progress over time on the two criteria above in public corporate reports.[9]

British Land, one of the largest property development and investment companies in the UK, announced in June this year that it plans to achieve a net-zero carbon portfolio by 2030. The firm, which already reduced its carbon intensity by 73% and embodied carbon in development by 16%, is creating a transition fund to finance its net-carbon journey. The company decided to source the capital for its fund internally by imposing an actual carbon price of £60 per tonne on every single one of its developments.[10]

In 2012, Microsoft implemented an internal carbon fee, applied on the scope 1 and scope 2 emissions from the company’s 12 business units, including its global data centres, as well as on a part of its scope 3 emissions such as employee air travel.

The US firm calculated its carbon price – ranging between $5-$10 per metric ton in recent years – by dividing the amount of investment needed to meet the company’s carbon neutral commitment by its annual projected greenhouse gas emissions. With the funds raised via its carbon fee, Microsoft has reduced emissions by 9.5 million tons of carbon dioxide, purchased more than 14 billion kilowatt-hours (kWh) of green power, and achieved more than $10 million per year in energy cost savings [11].

 

Read the other articles in the series:

Green commitments and green legislation

The business case for corporate environmental action

Investing in a smarter and greener infrastructure part 1 – clean energy and sustainable land use

Investing in a smarter and greener infrastructure part 2 – sustainable cities

Sustainable supply chains

 

Corporate clients who would like to discuss this topic further should contact:

Dr Arthur Krebbers, Head of Sustainable Finance, Corporates or

Varun Sarda, Head of ESG Advisory

 

[1] https://ec.europa.eu/clima/policies/ets_en

[2] https://www.worldbank.org/en/programs/pricing-carbon

[3] https://www.carbonpricingleadership.org/resource-library

[4] https://www.un.org/development/desa/dpad/wp-content/uploads/sites/45/WESP2019MYU_Report.pdf

[5] https://www.carbonpricingleadership.org/resource-library

[6] https://www.un.org/development/desa/dpad/wp-content/uploads/sites/45/WESP2019MYU_Report.pdf

[7] https://www.carbonpricingleadership.org/resource-library

[8] https://www.cdp.net/en/campaigns/commit-to-action/price-on-carbon

[9] https://www.unglobalcompact.org/take-action/action/carbon

[10] https://www.britishland.com/news-and-views/press-releases/2020/23-06-2020

[11] https://www.c2es.org/site/assets/uploads/2017/09/business-pricing-carbon.pdf

ESG/Sustainability


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