II. What is Internal Carbon Pricing? For What Purpose is Internal Carbon Pricing Used?
In today’s economic order, companies are subject to certain financial obligations through carbon pricing mechanisms based on the carbon dioxide emissions they cause. As this situation led companies to reduce their carbon emissions, conducting an examination of the economic profit-loss balance of investments required for carbon reduction and processes of a risk assessment becomes inevitable. Since the transition to environmentally friendly and low-emission technologies is
not at a scale that can be realized by using internal resources in some circumstances and it may be necessary to get benefits from some debt instruments. In this context, while companies implementing green and environmentally friendly technologies and projects or conducting environmental risk assessment processes, they determine an internal carbon pricing for the value of one ton of carbon dioxide emissions for the company. Internal carbon pricing can essentially be considered a planning and risk management tool. By voluntarily establishing internal carbon pricing mechanisms, companies find the opportunity to evaluate the risks and opportunities arising from their business processes, current policies and strategies, and green transformation actions. Especially in practice, the main reason for using the internal carbon pricing mechanism is the long-term emergence of such environmental and managerial risks for most companies, their uncertainty, and the inability to make a consistent estimation due to lack of data. Since assessing a monetary value to the cost of carbon emissions provides a convenient basis for companies to monitor their strategies in real time and adapt them to potential changes in the future. It has been noted that within the scope of the report generated with the participation of more than two thousand six hundred different companies from thirteen different sectors within the scope of the Carbon Disclosure Project carried out in 2019, 22% of the companies within the scope of the project already have an internal carbon pricing and 23% are working to establish an internal carbon pricing mechanism. It is understood that the majority of companies operating in particularly the energy, finance, and technology sectors already get benefits from internal carbon pricing in their structure. The benefits of internal carbon pricing, particularly such as its increased access opportunity to investors who consider sustainability and greenness factors as an important criterion in investment decisions, and that the company becomes more resistant to environmental risks, also should not be ignored.
II. What are the Methods Companies Use for Carbon Pricing in Practice?
Companies today can determine the cost and risks of a ton of carbon emissions for their companies in monetary terms by using four different methods, which are; (i) shadow pricing; (ii) internal carbon pricing; (iii) internal cap-and-trade system, and (iv) implicit carbon pricing.
a. Shadow Pricing
Shadow pricing is essentially a completely theoretical and hypothetical valuation of the cost of carbon emissions per ton for the company. Within the scope of this method, companies set a conceptual carbon price based on factors such as government policies that are expected to increase the carbon price. This value usually considers the highest estimate of the carbon price during the year. The shadow pricing method can be an effective tool by estimating how this price will affect business processes, strategies, capital investments, and risk management processes.
b. Internal Carbon Pricing
Within the scope of the internal carbon pricing method, companies charge one ton of carbon that they produce, and create an internal fund to be used for carbon emission reduction projects with a long payback period. In other words, within the scope of this method, companies essentially charge themselves for the carbon emissions that they produce. In this context, in the long term, they use their income accumulated in this fund for carbon reduction projects. In practice, it is observed that the carbon price determined in the internal carbon pricing method is determined as a lower level compared to the shadow pricing method.
c. Internal Cap-and-Trade System
The Cap and Trade method is a carbon pricing mechanism implemented in many countries and states, especially in the European Union, and an upper limit is determined by the governments for the carbon emissions that the companies can emit into the atmosphere within a certain period of time, and some financial obligations are imposed on the companies in terms of the amount exceeding this upper limit. By implementing this mechanism in the own internal processes by companies, the internal emission cap and trade system is formed. With the internal emission cap and trade method, companies determine an upper value for the carbon emissions emitted into the atmosphere as a result of their business processes. The company establishes free allowances for each ton of carbon emissions emitted, and business units can purchase and sell these free allowances among themselves. An internal cap-and-trade system is a good choice for holding companies and companies with different operations and operating in a variety of industries, since it reduces emissions company-wide while providing added flexibility to carbon-intensive business units.
d. What is Implicit Carbon Pricing?
The implicit carbon pricing is essentially generated in order to evaluate the profit-loss balance of the emission reduction projects of companies and to compare the cost of these investments with carbon-related taxes and other financial liabilities. The implicit price is basically used to calculate the cost of emission reduction projects such as renewable energy and energy efficiency to companies, and it is calculated retrospectively after the achievement of the emission reduction targets foreseen by these projects and primarily the cost of the company’s emission reduction projects and investments to the company are measured. In this context, every company that has targets for climate and energy has an implicit carbon price. In fact, more than one different implicit carbon price may be available at the same time within a company. This is entirely resulted from the diversity of the company’s emission reduction projects and investments.