With carbon taxes and regulations on the rise, companies must proactively manage their carbon expenses as part of their business decisions — just as they do their financial expenses. Proactive inclusion of carbon costs is the only way to minimize future risks and burdens that will come as more mandatory carbon taxes arrive. Failing to act now could result in significant financial and regulatory burdens in the near future. The European Union’s Carbon Border Adjustment Mechanism (CBAM) is one such example of impending regulations. Businesses exporting into the EU from outside can use internal carbon pricing (ICP) as a mechanism to effectively allocate the cost to greenhouse gas emissions directly into their products.
The Role of Internal Carbon Pricing
ICP helps businesses invest in low-carbon opportunities, prepare for regulations, and avoid stranded assets. Many industry leaders are already using ICP to prepare for future carbon costs. According to CDP, the number of companies now using ICP in their operational decision-making doubled from 2016 to 2021, particularly in voluntary and compliance markets in emerging countries.
The benefits of integrating ICP in companies are extensive, covering both internal operational improvements and external contributions to environmental sustainability and global climate action. Companies can stay competitive in changing regulatory environments by strategically positioning themselves to navigate forthcoming regulatory shifts, avoid potential penalties, and maintain market competitiveness. Additionally, cost savings and operational efficiencies can be achieved by streamlining resource utilization and reducing waste, thereby bolstering the bottom line while diminishing environmental impact.
Potential Impact of CBAM
To illustrate the importance of ICP, let’s examine the potential impact of the EU’s CBAM policy.
The EU’s CBAM policy promotes cleaner industrial production by pricing carbon emissions of imported goods, encouraging greener manufacturing in non-EU countries. Industries like manufacturing, automotive, food production, and construction will be directly impacted by the EU’s carbon border adjustment mechanism.
However, this will encourage climate action by urging suppliers and manufacturers to further decarbonize. Adopting a competitive carbon pricing on CBAM-covered products will be imperative for many companies, not only to remain competitive in the EU market, but also in future regulations. Strategic moves for companies will be required to facilitate a broader transition to low-carbon technologies, fostering economic growth while managing affordability.
Preparing for Upcoming Carbon Taxes
As carbon taxes like CBAM become more prevalent, companies must prepare now. Implementing ICP helps manage costs, drive innovation, and stay competitive by integrating carbon management into business decisions. This preparation ensures that when mandatory carbon taxes come into effect, businesses will already have everything in place to comply seamlessly.
Using CBAM as an example, here’s how to use ICP to ensure a smooth transition and maintain competitiveness in a carbon-conscious market:
- 2025: During CBAM’s transition period, companies should identify ICP goals based on decarbonization objectives, select appropriate ICP mechanisms, and pilot their approach.
- 2026: Analyze CBAM impacts and define an ICP strategy to reduce emissions. Scale the pilot to cover all Scope 1 and 2 emissions for CBAM-targeted products. Disclose emissions and decarbonization targets to EU clients.
- 2027: With CBAM fully in effect, continue decarbonization efforts to lower the carbon tax burden for clients and maintain competitiveness.
Mechanisms for ICP Implementation
Choosing the right approach for ICP implementation is crucial. There are three key mechanisms: internal fee, shadow price, and implicit price. By understanding these options, your company can effectively incorporate ICP into its sustainability efforts and make a tangible impact.
- Internal Fee: A payable fee per GHG ton that creates a dedicated investment stream to fund the company’s emissions reduction efforts.
- Shadow Price: A theoretical cost per GHG ton that helps the company prioritize low-carbon activities and evaluate the cost/benefit of strategies.
- Implicit Price: A cost based on how much it costs the company to implement emission reduction projects and comply with government regulations.
Fully Utilizing ICP
Embracing internal carbon pricing today will position your company as a leader in sustainability and ensure you are well-prepared for the regulatory landscape of tomorrow. Don’t wait for the regulations to catch up — start your journey toward a low-carbon future now.