‍From carbon to cash: Leveraging internal carbon pricing for business growth ‍

The recent momentum generated by increasing regulatory obligations and heated debates within major stakeholders in global climate change, such as the Science Based Targets Initiative (SBTI) group, could rival the seismic impact of the most significant trade regulation in history—akin to the magnitude of the Great Depression era tariffs. At the same time, SBTI is spearheading initiatives to expand offsetting to Scope 3 emissions, and new regulations like the Corporate Sustainability Reporting Directive (CSRD) are set to reshape corporate climate reporting standards, further amplifying the urgency for businesses to adapt to evolving sustainability frameworks.

Amidst the complexity of today's regulatory landscape, with offsetting facing continued scrutiny and costs skyrocketing, what should a savvy business do? As the saying goes, "Prevention is better than cure." At Plan A, we champion prevention first and then guide companies through their decarbonisation journeys. What's particularly captivating is that safeguarding the planet can also translate into hefty profits for your business. 

For more context, several internal meetings during COP28 among top stakeholders and investors sparked a surge in global investments in decarbonisation, and even before that, the investments were at an all-time high. According to a fascinating assessment of the global decarbonisation investment opportunity by the World Economic Forum, CapEx investments for climate solutions have soared to unprecedented heights, estimated at $1.1 trillion in 2022 by Bloomberg NEF and $1.7 trillion in 2023 by the International Energy Agency (IEA). But how can you ensure that these investments in abatement deliver long-term financial and environmental benefits? This article can help you find your answers.

The EBITDA of decarbonisation: The “Why” of forecasting your abatement cost

Decarbonisation has proven to be a global value-creation strategy that can increase cost-competitiveness in the long term. Evidence also suggests that 40% of the reduction actions in decarbonising the supply chain imply low costs, such as energy efficiency and renewable energy, compared to high-cost investments, such as shifting fuels or carbon capture. 

Speaking of value creation, many companies have already tapped into the potential of internal carbon pricing, recognising its power to drive significant transformations. Philips, for example, leverages an Environmental Profit & Loss (EP&L) account to illuminate primary environmental concerns and innovation opportunities, aiming to shrink the environmental footprint of their products and solutions. Notably, products and solutions designed with green and eco-friendly principles contributed to nearly 72% of Philips' revenues in 2022, showing a substantial increase from the previous year. In another example, Schneider Electric has initiated the Zero Carbon Project, which intends to reduce the carbon footprint across its supply chain by collaborating with its top 1,000 suppliers. Concurrently, Schneider leverages insights from its decarbonisation initiatives to cultivate new revenue streams. Their sustainability-focused business experienced a growth of over 20% in Q4 2022. However, how can one ensure that their investments yield profitable returns in the future? How did Philips achieve such impactful results with their EP&L account? By putting an internal price on carbon!

Climate transition and risk consultancies have constantly emphasised the effectiveness of integrating an internal carbon price within climate transition planning to bolster sustainability and resilience in businesses. As per KPMG’s interesting insights, there is a correlation between companies using an internal carbon price and high ESG scores, particularly for the Health care, Oil and Gas, and Banking industries (refer to the exhibit below). 

On the other hand, McKinsey has repeatedly echoed the importance of internal carbon pricing in its insights reports, highlighting how businesses can trim their Marginal Cost Abatement Curve (MACC) by acting promptly on abatement measures. According to McKinsey’s 2022 analysis, there's been a surge in the adoption of internal carbon pricing across industries, with nine sectors witnessing an average uptick of 10 percent or more between 2019 and 2021. But there's ample room for improvement, especially in high-emission sectors. Take the industrial sector, for instance. While internal carbon pricing has seen a 12 percent growth, it still encompasses only 38 percent of the top 100 companies (refer to the exhibit below). In the energy and materials sectors, which jointly contribute to about 60 percent of global CO2 emissions, only 50% or fewer of the largest companies have embraced internal carbon pricing.

Finding the right price for your carbon: The “How” of forecasting your abatement cost

According to CDP, an internal carbon price is one way of taking advantage of low-carbon opportunities while ensuring that investments' returns are smartly and wisely made. Many start by using the internal carbon price to reflect the cost of future emissions in investment decisions, effectively improving the economics of low-emissions projects while penalising high-emissions projects. This helps companies build a future-ready portfolio of low-carbon assets. Just think about the benefit of being able to predict future costs related to climate change ahead of time instead of finding out later and spending millions on reducing emissions and offsetting them. Innovative companies aim to profit from their efforts to reduce emissions while maintaining solid profits overall. Companies can also set their internal carbon price, as CDP recommends, and directly factor it into all their CAPEX and OPEX decisions.

It’s simple logic- if you’re informed of the hefty future monetary damages to your business from carbon-intensive assets, you will rethink your traditional investment path. Here is when the shadow price comes into the picture. By incorporating a shadow price into their CAPEX and OPEX decisions, companies can cut out their hefty future offsetting costs if planned strategically. The implicit or internal carbon price is typically calculated using a shadow price. But what is a shadow price? A shadow price is the monetary value a company assigns to its GHG emissions per ton, used to evaluate the potential cost or benefit of different decarbonisation investments. This may also be a regulatory price, as determined through an external carbon tax or the price of offsets in voluntary markets. Some companies often use the MAC as well.

To speed up the process of reducing emissions from existing assets, what’s a good practice, other than setting a shadow price, is to charge a fee for carbon on each asset. This involves connecting emissions to the performance of individual holdings in profit and loss (P&L) evaluations. Depending on the internal carbon pricing model used, the money generated from these charges can be spread over time to fund efforts to reduce the carbon footprint of each asset and invest in new low-carbon projects. Additionally, companies can include the internal carbon price in their purchasing processes for materials, utilities, and services that produce a lot of emissions to decrease emissions from indirect sources and encourage suppliers to decarbonise. 

Linking the need for an internal carbon price in decarbonisation investments to preventing future offsetting costs is not a way of saying that a carbon price will automatically control your business’s emissions in a vacuum. However, this price can warn you of your future climate risk if you do not act now. As a good market practice, it’s a push towards a well-planned decarbonisation journey. 

Ready to enhance your company's sustainability? Dive into strategic decarbonisation and turn challenges into profitable opportunities. Discover how Plan A’s tailored sustainability solutions can drive your business growth. Book a demo today.