Defining internal carbon pricing: the how and the why

The aim of carbon pricing is to help achieve ambitions in reducing greenhouse gas emissions. To do so, investments with a lower carbon impact are made more profitable.

Several pricing tools are currently in use. Two main market instruments exist: carbon tax and the greenhouse gas emission quota system. These two complementary levers allow for a direct price on CO2 to be put in place and to integrate a pricing signal by all economic players into their investment and consumption choices.

Another approach, called cost-effectiveness carbon pricing, defines a "benchmark value" for a tonne of CO2. Companies can use all these tools to define their internal carbon pricing, which is itself an essential lever for making investment decisions.

Two types of regulations

The CO2 produced by human activities is the main cause of global warming. Carbon pricing is one of the main levers for reducing greenhouse gas emissions. At both national and European levels, economic instruments have been put in place to put a price on carbon.

There are two types of regulations on the external market: carbon tax and the greenhouse gas emission quota system. Carbon tax is a direct tax proportional to the quantity of greenhouse gases (GHGs) emitted by an economic activity. This tax helps to change behaviours and steer investments towards less carbon-intensive projects. The emission quota system sets a limit on carbon emissions and allows companies that reduce their carbon emissions to sell carbon credits to other companies that have exceeded their quotas.

The price of carbon can also be conceived as a "shadow price", valuing the tonne of cut-down CO2 by its contribution to decarbonisation objectives [1]. A company can use these tools to set their internal carbon pricing.

A double objective: reduce emissions and anticipate poor investments

Carbon pricing is part of an approach to reduce greenhouse gas emissions. It enables companies to make carbon-free investments more profitable and to anticipate changes in taxes and carbon market prices.  Through these tools, companies take fewer risks in their activities and avoid investing in carbon projects that would be costly in the future.

As part of this approach, companies can define their internal carbon pricing.

Internal carbon pricing: a flexible tool

Internal carbon pricing can be designed as a tariff/ecotax or as a cost of decarbonisation, valuing the tonne of CO2 cut by its contribution to the national decarbonisation objective. It is a decision-making tool, not an end in itself. Internal carbon pricing is specific to each company and is calculated according to different criteria detailed further down.

Internal carbon pricing is a flexible tool that can take several forms [2]:

Shadow price: an economic value is assigned internally to investment decisions. It is a theoretical value that does not lead to financial flows. The aim is to understand the impact that a carbon price would have on strategy and on the calculation of the internal rate of return on a company's investments
Internal carbon tax: this consists of adding a bill for the emissions generated by operations to the cost of operations. By increasing the operational costs of carbon-intensive investments, the internal carbon tax leads to short-term emissions reductions while stimulating innovation in the long term
Implicit pricing or real cost of decarbonisation: this price is calculated in retrospect, based on an analysis of decarbonisation investments. It enables companies to measure the effectiveness of their decarbonisation projects

The shadow price of carbon: from €54 per tonne of CO2, in 2018, to €775 per tonne of CO2 in 2030

In the report from the Alain Quinet commission [1], a cost-effectiveness method was adopted to define a price of carbon based on the following principles:

Definition of the decarbonisation objective: net zero by 2050
Calculation of the resources needed to achieve this objective, using forward-looking models such as TIMES, IMACLIM, ThreeME, etc
Establishment of a trajectory for the evolution of the reference value: from €54/tCO2 in 2018 to €775/tCO2 in 2030

The shadow price of carbon values the tonne of CO2 removed by its contribution to the decarbonisation objective, in this case "net zero" by 2050.

This pricing, which was initially defined in response to a request to compare public investments, can be used by the state, a company or even an individual who wishes to take into account the well-being of the community.

A 3-dimensional implementation of internal carbon pricing

As explained above, internal carbon pricing is specific to each company and is made up of three main dimensions:

"Height" corresponds to the monetary value of one tonne of carbon. This price depends on the company and the country in which it is located
"Width" is the perimeter of emissions covered by the internal price of carbon. This perimeter varies according to whether scopes 2&3 (indirect emissions) and scope 1 (direct emissions) are taken into account
"Depth" corresponds to the integration of internal carbon pricing within the company. At what levels does it apply? The more it is taken into account at different levels of a company, the more it becomes a pillar of decision-making

For a company to make a real contribution to reducing CO2 emissions, it must take into account indirect emissions, i.e. those from suppliers, customers and the value chain as a whole.

3 recommendations for efficient internal carbon pricing

Maximise the effectiveness of internal carbon pricing by initially using the market price to set its trajectory and anticipate changes in market prices and carbon abatement costs
Integrate scope 3 emissions into internal carbon pricing by aligning the decisions of the company's customers and suppliers
Raise awareness of the concept of internal carbon pricing among financial players

The carbon tax and the greenhouse gas emission quota system are two complementary levers that can be used to put a direct price on CO2 and integrate a pricing signal by all economic players into their investment and consumption choices.

The shadow price, also known as "climate action value", is a valuation of the price of a tonne of CO2 abated in order to meet the global objective of limiting global warming to 1.5°C. Companies can set their carbon pricing according to their needs and priorities - in this case, the pricing can be aligned with the market price or with the shadow price.

The advantage of the shadow price is that it is not volatile. Lastly, although internal carbon pricing is adopted by companies on a voluntary basis, it is nonetheless an essential tool for decarbonisation and investment in low carbon projects.

[1] Prix interne du carbone : une solution qui tombe à PIC pour les entreprises ? | Institut Montaigne

[2] La valeur de l’action pour le climat | France Stratégie (strategie.gouv.fr)

About the author

Houda Maimouni

Houda is a Consultant Manager at Urbanomy.
A civil engineering graduate, she holds a master's degree in material science for sustainable construction from the École des Ponts ParisTech and a PhD in civil engineering from the École Centrale de Nantes. She has several years of experience in innovation consulting.
Today, she helps organisations on projects with energy systems simulation projects, defining decarbonisation strategies, carrying out technical and economic studies as well as developing and deploying detailed action plans.