The responsibility for reducing carbon emissions is frequently assigned to individuals and their carbon footprint. However, corporations also have a significant role to play. In fact, the biggest corporations have accounted for more than two-thirds of global emissions since the start of the Industrial Revolution.
Internal carbon pricing (ICP), also referred to as “shadow carbon pricing,” is a potentially powerful tool that corporations have at their disposal in order to contribute their fair share to the effort to reduce CO2 emissions. First thought up following the Kyoto Protocol in 1997, which laid the foundations for carbon pricing and offsets, shadow carbon pricing is a voluntary method for companies to estimate the costs of their greenhouse gas emissions to society, even when all or part of their operations are out of the scope of external carbon regulations.
My research at the EDHEC Risk Climate Impact Institute seeks to test the robustness of these accounting methods in the private sector and its complex modelling.
influencing future decisions
In order to establish a shadow carbon price, organizations must evaluate their energy consumption, supply chain operations, waste management, and direct and indirect emissions from their own sources. Emissions from combustion in a company’s furnaces or from its vehicle fleet are direct emissions that are either owned or controlled by the company. The estimation of indirect emissions is based on the purchase of energy, including electricity, heat, and ventilation. Lastly, indirect emissions in the supply chain, such as refuse disposal or material transportation, are considered.
Additionally, the current and projected future carbon prices are assessed. This intricate process is essential for comprehending the long-term pattern of carbon prices and the potential impact on the performance of companies in the future. The company must evaluate the climate policies in the countries where it operates and intends to expand in order to arrive at these estimates. Companies should also consider the potential for significant changes in the price of carbon in each of the target countries, which could be influenced by major political, technological, and economic developments.
Companies will be able to establish their internal carbon price only after they have obtained the aforementioned information. To determine the price for a ton of CO2, they can use the current market transactions; in Europe, for example, it is known as the EU Emissions Trading System. In other markets, carbon tax rates can be found in national tax laws.
Effect on the valuation of the company
This tool not only enhances the decision-making processes of companies but also facilitates communication with investors. Increasingly, climate-aware investors are scrutinizing the plans that companies have disclosed to facilitate the transition to a low-carbon world. What businesses interpret as ICP validates the legitimacy of the long-term strategy and the actions taken by businesses to successfully compete on a planet that is dangerously warm.It is financially logical to incorporate the “carbon price” into the company’s valuation, as carbon-related risks can have a substantial influence on a company’s cash flow.
For instance, when an energy company is required to make a decision regarding the construction of a new facility, they can compute and contrast the anticipated expenses of a fossil fuel-based option and a renewable energy option. Traditional, more polluting sources of energy may be more convenient when a baseline valuation is conducted without accounting for the potential future increase in carbon prices. Nevertheless, the financial convenience of transitioning to a cleaner source of energy may be realized by the company when the costs associated with the future carbon footprint become so prohibitive that the valuation also takes into account the future evolution of carbon pricing.
In this manner, they can make well-informed decisions that incorporate the shadow cost of carbon use, thereby enhancing the quality of financial investments. In conclusion, carbon risk assessment is not only a critical component of the global effort to combat climate change, but it also assists companies and investors in overcoming the intricate obstacles of a swiftly evolving business environment.
A jumble of regulations
Nevertheless, the current regulations concerning environmental policies are highly inconsistent among countries. As a result, carbon prices ranged from 1 cent to more than $130 per ton in 2023 (World Bank)—a textbook example, if there ever was one, of how stronger climate policies could spur greener business decisions.
As climate change policies and carbon prices evolve rapidly, companies will increasingly need to measure their exposure to carbon risks. In reality, the management of carbon risk should be regarded as equally significant as any other conventional risk within the organization, such as currency or compliance risks.
