Having a dedicated decarbonisation budget builds a financial case for companies investing in carbon projects, writes Valerio Magliulo
The focus of this year's annual United Nations (UN) climate conference was on setting a new climate finance goal, which will enable the mitigation activities needed to protect society against the worst impacts of climate change.
But how do we tread the line between the private sector committing vast sums – in the billions – to climate action, whilst also funding its own decarbonisation efforts?
Setting an internal carbon price (ICP) is a proven and effective route. It can not only create a budget for internal decarbonisation activities, earmarking funding for external climate action projects, it allows companies to hedge against future climate risk.
Internal carbon pricing: An untapped opportunity
Though an ICP comes in many forms, at its core it is a financial value placed on a company's emissions. By assigning each tonne of emissions a carbon price, companies can understand the risks and costs associated with their environmental impact and factor this into strategic decision-making.
This is an important step forward for climate action at a company level. It brings sustainability under the jurisdiction of financial directors. It enters carbon onto the balance sheet and out of traditional corporate social responsibility.
When implemented well, it should encourage investment into efficient low-carbon technologies and operations, spurring positive change.
The use of an ICP is on the rise, but still far below its potential. Cumulatively, only 25% of the largest 100 companies in each major industry have one.
Plus, setting an ICP isn't the only goal. The set price must be ambitious and linked to the 1.5°C pathway of the Paris Agreement. Otherwise, it's missing out on the opportunity to affect real change and impact.
In fact, McKinsey found fewer than 5% of organisations with ICPs, in the three sectors with highest ICP adoption, priced emissions at rates in alignment with 1.5°C.
The price must also be high enough to incentivise action. Too low and there will be no deterrent to continuing business–as–usual activities that are harmful to the planet.
Though the price will vary by industry — companies from Klarna to Microsoft and Disney to Swiss Re have set prices ranging from $15–$100 per tonne — initiatives like the UN Global Compact have called for a minimum level of $100 per tonne, while the High-Level Commission on Carbon Prices recommended $50–$100 by 2030. As it stands, many companies are well off this.
ICPs provide decision-making clarity
Climate change is a company's biggest liability. Without getting on the front foot and proactively managing climate risks – through, for example, investing in technologies and efficiencies that lower emissions – businesses will be hit financially.
Business models must be adapted, but it can be difficult to know where to begin. The budget created through setting an ICP is an important starting point. If a company with annual emissions of one million tonnes sets a carbon price of $25 per tonne, for example, it creates an annual budget of $25 million. The financial director can then use this as a benchmark for evaluating proposed emissions reductions solutions.
Critically, this supports forward-looking planning based on a rational, financial metric, while encouraging businesses to account for future emissions. Equipped with this benchmark, business leaders can spot inefficiencies in their internal processes and make a business case for sustainable investments.
What does this mean for international climate finance?
Evaluating internal emissions reductions activities is one side of the coin. Although companies should prioritise internal and value chain decarbonisation, supporting climate action projects — such as investing in off-grid solar in countries with low energy access, or nature-based solutions in areas with degraded ecosystems — is increasingly recognised as needed to tackle the international finance gap.
Having a dedicated decarbonisation budget builds a financial case for companies investing in these projects.
If, taking one small example, the 1,097 companies with a science-based target in 2022 set an ICP of $50 (covering Scope 1 and 2 emissions), and dedicated 10% of the resulting budget to external climate investments, $2.1 billion would be immediately directed towards international climate finance.
If this was extended to Scope 3 emissions, or companies without science-based targets were to adopt the same approach, this figure would increase exponentially.
There is a challenge ahead for companies and sectors to gauge what an ambitious cost of carbon is. The good news, however, is that ICPs should not be static, set once and then forgotten about. They should evolve over time with the latest science and societal expectations.
I encourage business leaders to not be held back by this challenge. Move forward with the information you have now and iterate as you learn more.
We don't have time to act only when perfection has been achieved. We must leverage all options to raise the trillions of dollars needed to stem the climate crisis. ICPs can be an effective part of the solution.
Valerio Magliulo, CEO and Co-Founder, Abatable.