The price of carbon: A definition and current status

According to World Bank data, only 56% of the world’s population and 68% of economies are committed to reaching zero emissions by 2050.   

This is why many public and private organizations participate in the fight against climate change. One of the mechanisms used by these organizations is related to the price of carbon, also called carbon pricing.   

In this article, we will discuss the concept and current status of the price of carbon. The latter represents the price set internally by companies to manage and develop decarbonization strategies.     

 What is the price of carbon? 

The price of carbon is the price of emitting greenhouse gases into the atmosphere. It is an economic thermometer that quantifies the costs of the environmental damages caused by the operations of different industries. Its main objective is to lead the way towards a low-emission economy.     

Many countries have established carbon taxes or an Emissions Trading Scheme (ETS).    

What is an ETS?  

An ETS (Emissions Trading System) is a system that sets a limit and a price on GHG emissions. The goal is that those companies/industries that generate emissions below the established limit can sell their units to other entities as carbon credits at a carbon price previously established by the market.   

In LATAM, Mexico is already piloting an ETS. It is expected to be 100% effective by 2023. Colombia and Chile are in the process of analyzing and setting up an ETS in the short term.   

Companies quantify their environmental impacts through the internal price of carbon based on a monetary value. This allows them to transform their activities and reduce their emissions or assume the associated costs. 

  Why is it important to establish a price of carbon? 

Value creation is the primary goal of businesses, but there is no value without sustainability.   

Internal carbon pricing emphasizes incorporating additional factors into the monetary value analysis. Some of the main benefits of carbon pricing are:   

• It mobilizes domestic investment and generates revenue streams to create sustainable development policies.   
• Energy efficiency and security projects could be promoted through the revenues derived from the price of carbon, as well as waste and pollution reduction policies.   
• They require the creation of technological capacity at a national level,    
• The monetary penalty derived from its setting is a motivation for countries and companies to mitigate the causes that generate global warming.   

• Allows budgeting of future emission offsets that companies or governments may wish to make through Offsets/Carbon Credits.   
• Analyze the potential environmental impact of investments, allowing the relocation of assets to less polluting or more climate change resilient businesses.   

According to a recent World Bank report,    

“We are at a unique moment where setting a price of carbon can contribute to a resilient, inclusive, and sustainable post-pandemic recovery and help countries pursue a low-carbon growth path.”   

How does a company set an internal price of carbon? 

Below are some of the most commonly used internal carbon pricing methodologies and instruments:   

• Internal scheme or emissions tax: this methodology establishes a direct tax on carbon emitters where all operating units of the business participate. The “fines” paid by those that exceed the emissions cap can be used for investments in energy or industrial efficiency projects that target emissions reduction.    
• Emissions trading system: This system is based on a regulatory body external to the companies that sets a limit on the total amount of emissions that a business can emit. If companies exceed their allowable limit, they must obtain credits from other companies or buy carbon credits to offset their surplus.   
• Fuel taxes: Direct taxes are set on the purchase of fossil fuels. The goal is to discourage the purchase of fossil fuels and motivate private companies to switch to clean energy sources.   

• Offsetting: This method takes as a reference the cost to purchase of VCUs (Verified carbon units) equivalent to 1 TNCO2eq avoided or absorbed from the atmosphere.  
• Shadow price: The emission cost is calculated theoretically to weigh the future cost of carbon in all the company’s operations. Generally, a high price, e.g., US$100, is used as a reference to stress the carbon price in business decisions.   
• Hybrid carbon pricing systems: These use different methods combined. Many current markets operate as hybrid systems with temporary measures until the above systems are fully implemented.   

  What is the price of carbon? 

According to a World Bank report, currently (2021), the average carbon price is around US$ 2 per ton of CO2 equivalent emitted.    

However, according to the Stern/Stiglitz Commission, to meet current decarbonization targets, the price should rise to between US$50 and US$100/tnCO2eq by 2030.   

According to the International Energy Agency, to meet the Paris agreement targets, the carbon price should:   

• Increase to 75 to 200/tnCO2eq by 2030 and;   
• To 125 to 140/tnCO2eq by 2040.   

According to the 2021 CDP report, the average internal carbon price used by companies is U$S 25/tnCO2eq. And its maximum value is US$ 200.    

As it can be seen, different sources generally report different values. This is because the price set depends on the calculation method used and the companies evaluated in the sample. 

 Which companies use carbon pricing? 

According to the CDP 2021 report, more than 2,000 companies use the price of carbon or internal carbon pricing. These include more than 100 Fortune 500 companies that use or plan to use it.   

This number represents a 54% increase over the companies surveyed in 2017. The financial industry is the biggest driver of this growth.   

The following graph represents the growth in the price of carbon over the last decade:  

Conclusions  

Internal carbon pricing is a tool increasingly used by companies and investors. Its main goal is to define and evaluate its business strategies based on its carbon emissions.    

In addition to this tool, there are other actions you can take today to reduce your company’s environmental impact. 

If you are looking to set your reduction targets based on SBT, Carbon Neutral+ can help you 

Among the services offered by CARBON NEUTRAL+, two of them that are useful for companies that want to apply to this increasingly important initiative: the carbon footprint measurement performed under the GHG Protocol standards (approved by SBTi), and the operation with renewable energies through BIOREC+. These will allow them to reduce their carbon footprint scope 2 and thus add points and be aligned to multiple reduction targets.   

If you want your company to be part of SBTi, contact us  and we’ll reply as soon as possible to find the best way to add points and set carbon reduction goals. 

References 

CDP. Putting a Price on Carbon: The state of internal carbon pricing by corporates globally. 2021 

Banco Mundial. Liderazgo en la fijación del precio del carbono en 2020-21. 2021 

Parlamericas. Manual sobre la fijación del precio del carbono.