Internal Carbon Pricing – on the pathway to net-zero or just another sidetrack?

Leading into the last federal election, the then Labor opposition promised no economy-wide carbon price under its leadership, reflecting the continued vexed nature of climate policy in Australia. Since regaining leadership, the Federal Labor Government has maintained this promise, instead pursuing emissions reductions through targeted sectoral reforms.

Intriguingly, many businesses have started to set their own internal carbon price based on an evaluation of the various government decarbonisation policies. Now under new reforms being proposed by Treasury, these businesses will be required to disclose their internal carbon price from 1 July 2024.  

The features of an internal carbon price

An internal carbon price is a tool that companies use to incorporate the costs of greenhouse gas emissions into investment and capital decision-making. There are several reasons why an organisation might use an internal carbon price:

• Incentivise and attract financing for low carbon investment – responds to growing investor and community expectations that future business projects are sustainable.
• Navigate existing or future carbon regulations – imprints carbon pricing as familiar and normal within the business, allowing companies to be ready for domestic or foreign government emissions reduction policy, including the expected ratcheting of carbon prices over time.
• Transparency of internal business behaviour – enables business to understand their carbon footprint and the major contributors, which can spur innovation to improve energy efficiency and uptake of carbon-efficient technologies.

An internal carbon price can be implemented in different ways, with the most common being:

• A shadow price – a notional cost that a company uses to inform its finance and investment decisions. It imposes no actual cost on the business.
• Implicit price – a cost calculated based on what a company incurs when it implements emission reduction measures, usually because of indirect government carbon policy (e.g. a renewable energy target, energy efficiency program).
• An internal tax or fee – an actual cost the company charges to certain business activities based on its greenhouse gas emissions. This fee is then usually diverted into an internal investment scheme to fund low-carbon technology: e.g. renewable investment, energy efficiency, and carbon removal projects.

Treasury and the Australian Accounting Standards Board (AASB) are proposing through its draft Australian Sustainability Reporting Standards that companies can choose which type of internal carbon pricing to use, so long as they disclose an explanation and price:

Figure 1: Climate-related Metrics - Internal Carbon Price

Source: AASB Australian Sustainability Reporting Standards consultation

As part of that explanation, businesses will probably need to explain what reference point or metric has been used to set the price. Broadly, these approaches are:

• External carbon reference – a point-in-time measure to determine the value of carbon. This can include reference points like an international carbon price (e.g. the European Union’s Emissions Trading Scheme) or domestic (e.g. the Safeguard Mechanism price).
• Carbon forecast – using a scenario forecast of emissions to meet a particular climate target (e.g. AEMO’s Integrated System Plan).
• Tailored carbon price – selecting a carbon price forecast and then making adjustments based on an assessment of specific business risks and objectives (e.g. a renewable investment target).

Internal carbon pricing is steadily gaining pace overseas  

The Carbon Disclosure Project (‘CDP’) is a non-government organisation that is considered the authoritative database for information on internal carbon pricing. It tracks and monitors the practices of over 5,000 companies which self-report their carbon pricing data to the CDP.

The CDP collated its findings in a 2021 report called Putting a Price on Carbon, as well as providing further analysis to Reuters at the end of 2023. The CDP found about 20 per cent (or just over 1000) reporting global companies use an internal carbon price. The chart below breaks down those companies by region.

Figure 2: Growth of internal carbon pricing by region

Source: 2023 CDP data cited by Reuters

The CDP also tracks growth in other regions – Africa, Oceania, and South America – though uptake there is considerably lower.

Interestingly, while many companies report plans to adopt an internal carbon price, few actually do so. The CDP’s 2021 data had projected over 2000 companies using internal carbon pricing by now (853 already, 1159 anticipated to). This slower than expected uptake might unfortunately reflect a greenwashing aspect to internal carbon pricing – i.e. commitments are easy, but implementation is much harder. 

For those companies with an internal carbon price, a shadow price was the most common type (used by about half of reported companies with a price) and tends to attract a higher dollar value compared to internal fees, presumably because of the absence of any financial impact. One example is Amgem, an American pharmaceutical company, which has by far and away the highest internal carbon pricing of reported companies – a shadow price of US$1,600 per metric ton and an internal fee of US$1,000 per metric ton for capital projects with greater than 500 metric tons of CO₂. None of its projects in 2022, however, were subject to the internal fee.  

Identifying patterns in the prices companies set is difficult due to fluctuations across business types and regions of operation. Probably the first pattern is that companies are assuming relatively low carbon pricing, with the median price in 2020 being US$18 per ton for an internal fee and US$28 for a shadow price. More recent analysis (see figure below) shows the range of internal carbon pricing across companies – though it does not distinguish between types.

Figure 3: Internal carbon pricing average of companies (US$/ton)

Source: World Bank and CDP data cited by Financial Times

Probably the most well-known example of an internal fee in action is Microsoft. Microsoft charges a fee of US$15 per ton for scope 1 and 2 emissions, US$100 for business travel, and US$8 for all other scope 3 emissions. Scope 3 emissions make up over 96 per cent of Microsoft’s emissions (or 12.5 million tons). These fees are then diverted into a carbon investment scheme to support energy efficiency and carbon removal projects.

The other pattern is probably expected and that is companies operating in a jurisdiction that explicitly prices carbon (either through a tax or cap-and-trade arrangement) tend to set higher internal carbon prices. But therein lies the dilemma: jurisdictional carbon pricing also fluctuates wildly.  

Figure 4: Comparison of ETS price trends across select jurisdictions

Source: World Bank  

What might internal carbon pricing look like in Australia then?

The Australian Council of Superannuation Investors (ACSI) published a report in August last year about climate change disclosure, which found 41 of the ASX200 companies are already disclosing an internal carbon price.

Figure 5: Example of select companies that use internal carbon pricing for investment decisions

Source: ACSI Promises, Pathways, and Performance Report

This number will almost certainly increase over the next few years as Treasury’s climate disclosure regime commences, even as some reporting companies opt to declare that they are not applying any internal carbon price.

For those companies that do implement carbon pricing, there will be different options for how they choose to benchmark. The obvious reference point for some will be the Federal Government’s Safeguard Mechanism reforms, which enforces a “baseline and credit scheme” on large industrial emitters. Commentators have claimed this is a carbon price of sorts in Australia because it requires captured industrial facilities to purchase offsets (ACCUs) for any emissions above their baseline, making ACCUs a de-facto carbon price. ACCUs are currently priced at $35 but are expected to rise over the coming years as baselines are tightened.

Of course, for those companies not captured (about 70 per cent of Australia’s emissions) the Safeguard Mechanism might not be a reliable proxy. For example, the electricity sector does not have a clear carbon price signal even though it is leading Australia’s decarbonisation efforts. It instead relies on a mixture of government underwriting schemes and state-based electricity plans to safely replace coal-fired power generation with cleaner energy.

Electricity companies might decide then that scenario forecasting around when coal-fired power generation will close might be a better benchmark, especially if AEMO were to make transparent the methodology and cost of carbon it uses for its Integrated System Plan. Alternatively, a simple reference point might become available once the Federal Government publishes its emissions reduction value to inform the AEMC’s interpretation of the emissions reduction objective.

Either way, without an economy-wide carbon price and different emissions reduction pathways and policies across the sectors, Australia can expect to see reasonable fluctuations in the internal carbon pricing of companies. This is not a fatal flaw; on the contrary, it is what the reporting framework is designed for: to provide investors, shareholders, and the community with transparency of how companies are valuing carbon in their financial and business decisions.

Ultimately, what should be remembered is there is no magic substitute to effective government carbon policy. If governments can provide the private sector with efficient abatement signals, then internal carbon pricing is a useful additive that will only accelerate the transition to net-zero.