As companies work to cut emissions and achieve net zero, an internal carbon price has become a more frequently used tool for companies to convert emissions metrics into dollars.
"Carbon pricing can be a useful tool that allows executives who don't think in metric tons of GHG to think in dollars," said Simon Fischweicher, head of corporations and supply chains for CDP North America. "It turns these decisions into the language that they speak — language of finance."
CDP’s research has shown that the number of companies either using or planning to use an internal carbon price has increased 80 percent between 2015 and 2021. Nearly half of the 500 biggest global companies factor carbon accounting into their business plans, with internal carbon pricing most commonly used in the power industry. Since 2014, when CDP started collecting data, the number of companies using an internal carbon price jumped from 150 to 835.
In a McKinsey report, 23 percent of 2,600 companies it looked at reported using an internal carbon price, and 22 percent were planning to implement one in the next two years.
According to Fischweicher, some companies are starting to use an internal carbon price to understand and monetize the risk of climate change, while others are doing so to prepare for possible future regulations,
But for Spencer Reeder, director of government affairs and sustainability at Audi of America, that’s a bit of a pipe dream at the moment.
"I wish a federal carbon tax was on the horizon, but anyone who has been following carbon taxing will tell you that’s not the case," he said. "We are doing it to take responsibility for our own carbon."
The highest use case, according to Fischweicher’s research with CDP, is to drive low-carbon investment by demonstrating the cost-effectiveness of an energy efficiency project or choosing one asset such as a building or manufacturing service versus another. These investments and choices are necessary especially as companies start inching toward their net-zero commitment deadlines.
"Companies who have set science-based emission reduction targets, and are committed at the executive level to achieving these ambitious targets, do need tools that help them better assess projects to meet those goals," Fischweicher said. "And that's where a tool like carbon pricing allows them to evaluate opportunities to reduce emissions."
But what exactly is an internal carbon price?
Types of internal carbon pricing
An internal carbon price is a predetermined dollar value applied to the emissions generated by various business units in the company. The idea is that applying this tax, fee or price to carbon emissions will make traditional but cheaper technologies the same price as the more costly but more carbon-efficient projects — thus encouraging investment into low emissions technology that might be more expensive, causing behavior changes such as flying less frequently or helping evaluate facilities for their future carbon emissions and not just for traditional building and electricity costs. But there are different types of internal carbon prices, and how they are used inside companies varies.
Implicit prices can be very influential when embedded into cost calculations instead of just being used as a discussion point.
According to Fischweicher, most companies that have adopted an internal carbon price are using a shadow price, a mechanism that is applied to investment decisions but in which no money is actually exchanged.
"[The company] integrates a carbon price into that decision-making process," Fischweicher said. "It doesn’t necessarily mean that [the company] ends up making the decision with that shadow price in mind."
An implicit price is slightly different than a shadow price. According to CDP’s Global Price of Carbon Report, an implicit price, used by 19.3 percent of companies CDP surveyed, is "calculated retroactively and is based on how much it costs a company to implement projects linked to emissions reductions such as the purchasing of renewable energy or energy efficiency projects."
Implicit prices can be very influential when embedded into cost calculations instead of just being used as a discussion point. According to Mischa Repmann, senior sustainability and risk manager at Swiss Re, starting with an implicit price that doesn’t actually cost the company money can help get executives on board for a more impactful fee in the future because the price is already being factored into decision-making, even if no money is changing hands.
"I think that the biggest challenge within the internal carbon pricing space is going from an evaluation tool into a true decision-making framework," Fischweicher said.
Internal fees on carbon create real flows of money in an organization. This approach applies a tax to different operational departments dependent on their carbon emissions that is then aggregated into a carbon fund for offset purchases on low-emissions investments. The most common form of internal fees is applied to business travel. Microsoft, Swiss Re and Audi all use explicit internal fees on at least some part of their Scope 1 and 2 emissions or business travel.
"It’s really a fee, a levy tax, that we are charging to the business units, for all the operational emissions that we have in our compensation scope," said Repmann of Swiss Re. Swiss Re has been climate neutral since 2003, compensating for Scope 1, 2 and some operational parts of Scope 3.
According to Elizabeth Willmott, carbon program manager at Microsoft, the software company creates a carbon budget for each department with its internal finance department and collects the internal fee. Microsoft also engages in variance pricing, another nuance of internal carbon pricing. Instead of using one company wide price on carbon, Microsoft has created three tiers of pricing: The first is for electricity at $15 a ton, and the second is for business travel at $100 a ton. The remaining emissions charge, which covers removals, is a floating rate that is going to increase over time; in 2022 it jumped to $120.
According to the CDP report, Sony uses a different price for each business unit depending on a review of the department that takes into account the business condition and status, environmental impact, energy pricing, business size, budget and management status.
So how do companies pick the price to charge their internal departments?
How to set an internal carbon price
According to Fischweicher, the burgeoning carbon market acts as a good starting point for many companies setting internal carbon prices. CDP’s analysis pegged the median internal carbon price in 2020 as $25 per metric ton of CO2, with companies in Asia and Europe implementing the higher average price of $28. Audi looked at the cap-and-trade model for price but ended up using the Obama administration's social cost of carbon of $46 as the price floor as a starting point. The social cost of carbon is the estimated dollar cost of emitting one ton of CO2 into the atmosphere on things such as human healthcare costs and future environmental costs. The Trump administration drastically cut this to $1 to $6 per ton, but Audi is still using the Obama numbers. As of January 2021, Audi charges itself $200 a ton.
But many companies know that these market prices are too low to facilitate real and high-quality carbon removal or abatement. Each company GreenBiz spoke to noted that it wanted a price that was high enough to encourage behavior change.
"What level of price signal would invoke a reconsideration for whether the airplane flight was truly necessary or whether that meeting might succeed as a virtual meeting instead?" Reeder said about Audi's strategy.
The goal is to enable low-carbon decision-making and help people think in dollars instead of in metric tons. Repmann had a different philosophy for choosing a price for Swiss Re. Instead of focusing on the price as a punishment, he suggested companies ask themselves, "What am I willing to spend on climate finance?" and structure the price around that number. He cited the U.N. Global Compact calling for a minimum of $100 spending per ton as his benchmark for an internal carbon price. By using these criteria, companies hope to avoid the race to the bottom in costs and quality of carbon credits typically seen in the market.
According to Fischweicher, most companies are pegging the internal carbon price to the price of high-quality carbon offsets. Repmann said Swiss Re uses a blend of expensive carbon removals such as direct air capture, which can cost up to $1,000 per ton, to cheaper avoidance emissions such as forestry protection that can cost $100 per ton to calculate an average of $112 for the internal carbon price. That price is set to tick up to $123 next year.
How to charge it
Once you’ve set a price, you have to start charging it, and according to Fischweicher, Microsoft is the standard when it comes to carbon pricing models.
According to Willmott, Microsoft uses a three-step process for charging internal business units the price. First, of course, is accurate accounting and tracking of the emissions from each department including all scopes, direct operations, electricity procurement, supply chain, product and electricity use. Microsoft calculates and reports greenhouse gas inventory to CDP. Then in tandem with the central finance team, the corporate affairs team charges each business group the carbon fee for its portion of emissions based on building energy use, data center energy use, suppliers picked and products they’ve designed. The money — taken from each department’s regular budget — is then collected into a central carbon fund that is used for purchasing carbon reductions and removals (read our report about those removals). Once the backward-looking process is over, Willmott and her team start looking toward the future to create new budgets for each business unit for the next year.
"The funding for carbon reduction and removal projects helps to not only meet our carbon-negative commitment but also help to jump-start critical decarbonization markets," she said.
Some business departments at Microsoft have seen the carbon price as a challenge. In 2020, when Microsoft expanded the fee to cover Scope 3 emissions, the Xbox team got excited about trying to gamify (appropriately) the carbon budget by trying to make the new Xbox as efficient and sustainable as possible — looking at the carbon fee as something to avoid as much as possible. The team developed strategies based on a life-cycle assessment, such as an energy saver mode instead of standby to reduce energy consumption and offering free ground shipping to avoid air fuel costs.
"But don't be daunted by trying for perfection," Willmott said. "I think the very fact of trying to mainstream the cost of carbon into a corporate balance sheet is important on its own. Start small. Microsoft started with a small fee in 2012. We tested it out, and our stakeholders ended up really liking it. And it's developed a life of its own. I would say, get the ball rolling."