More companies worldwide are turning to internal carbon pricing as an effective tool to spur the transition to low-carbon technologies, and C2ES is helping organizations to explore this frontier through a new working group to share best practices.

By putting a price on the carbon pollution associated with business activity (read our brief), companies can account for their operations’ climate impact and incentivize actions to achieve their emissions reduction goals. Pricing carbon also responds to stakeholder and investor calls for climate action and prepares businesses for future carbon pricing regulation.

According to CDP, more than 1,200 companies either currently price their carbon emissions, or plan to within the next two years. Meanwhile, more than 120 companies have joined the World Bank Carbon Pricing Leadership Coalition that brings together government, the private sector, and civil society to support effective carbon pricing systems and policies.

This movement isn’t restricted to developed economies. This month, Mahindra & Mahindra became the first Indian company to implement an internal carbon fee (US $10 per ton) to help achieve its goal of reducing greenhouse gas emissions 25 percent over the next three years.

There are a range of ways to implement an internal carbon pricing strategy. The most direct is an internal carbon fee, such as the one Microsoft uses in its pioneering program.

Microsoft, which pledged in 2012 to go carbon neutral, implemented an internal carbon price in 2013 to help reach its goal. Microsoft charges the fee on the company’s scope 1 (direct) and scope 2 (purchased electricity) emissions, including its global data centers, as well as a part of its scope 3 emissions (business air travel).

The fee has helped the company reduce its carbon dioxide equivalent (CO2e) emissions by 7.5 million tons, achieve $10 million in annual energy savings, and invest in 10 billion kilowatt hours of renewable energy as well as support carbon offset projects around the world.

TJ DiCaprio, Microsoft’s senior director of environmental sustainability, said the benefits of the internal carbon fee include:

• It’s easier to target action. By quantifying the carbon emissions of different parts of the organization, it became clear where reductions were possible to meet the company’s carbon neutrality pledge.
• It provides incentive to act. The fee for emissions is charged to each department’s budget. This motivates decision-makers to take meaningful action toward emissions reductions, find low-carbon alternatives, and invest in carbon-saving projects. Even simple steps, such as reducing airline travel, made a real difference in the final accounting.
• It creates a dedicated funding source for action. The fees charged to departments are placed in a centralized fund that Microsoft uses for a variety of projects, from purchasing carbon offsets to investing in programs supporting e-waste recycling.

Among the key lessons for other companies from Microsoft’s experience:

• Set clear objectives you would like your carbon pricing model to meet.
• Align your carbon pricing model to support those objectives.
• Anchor the carbon price across all business units to drive accountability, employee engagement, and a cultural and behavioral change.

While an internal carbon fee prices carbon pollution directly, companies are also using indirect strategies, such as shadow pricing and implicit pricing.

Shadow pricing—a more common approach—is used by companies including BHP Billiton, Duke Energy, EMC, Google, NRG and Shell, as a risk assessment tool. It is the hypothetical or assumed cost of carbon emissions used to evaluate large investment decisions and profitability of projects in light of government regulation and/or the impacts of climate change. Compared to the more direct approach that companies such as Microsoft are taking, however, shadow pricing is not actually reflected in a company or division’s profit and loss statement, thus it may not have the same incentivizing effect.

Implicit pricing, another form that is used by companies including Unilever and Novo Nordisk, is simply a price calculated based on how much a company spends to reduce its greenhouse gas emissions, including the cost of complying with regulations. Here, the price reflects actions taken, rather than being a charge that drives change. Recognizing how much a company spends to meet its internal greenhouse gas targets and/or regulatory requirements can encourage greater action. Some companies, for example, employ an implicit pricing strategy as the first step before establishing a direct carbon fee.

Internal carbon pricing is a relatively new tool that can play a critical role in helping companies achieve aggressive greenhouse gas reductions. Through our Business Environmental Leadership Council, C2ES is engaging companies on internal carbon pricing strategies.  Please contact us if your company would like to learn more about internal carbon pricing as a business strategy.