A hodgepodge of regulations around the world has resulted in nearly a quarter of global emissions falling under carbon taxes or emission trading schemes, according to the World Bank. To some extent, by putting a price on greenhouse gas emissions, these mechanisms cause companies to reflect on whether the direct cost of emitting is worth it — much like how putting a price on hiring causes companies to reflect on the cost/benefit of increasing headcount.
However, this mandatory, external carbon pricing isn’t always sufficient to nudge organizations or societies toward more ambitious goals, like limiting global temperature rise to within Paris Agreement targets. And the majority of emissions occur outside of these regulated areas anyway.
So, companies are increasingly establishing their own internal carbon pricing, which can complement external carbon pricing schemes or stand independently to advance emissions goals.
But what exactly does internal carbon pricing look like, and how does setting a price benefit companies? In this guide to internal carbon pricing, we’ll walk through the most important things to know about using this approach to emissions management.
What Is Internal Carbon Pricing?
Internal carbon pricing is a rate that organizations apply to their own emissions, with a set price per tonne of carbon-dioxide-equivalent emissions (tCO2e).
For example, a large enterprise with internal carbon pricing of $15 per tCO2e that emits 5 million tonnes per year would essentially charge itself $75 million for its emissions. Then, if the company can reduce emissions by 20% next year, its costs would be $60 million instead of $75 million.
Internal carbon pricing can either be a theoretical charge, known as a shadow price, or an actual transfer of funds among departments, known as a carbon charge.
Why Set an Internal Carbon Price?
A primary reason for setting an internal carbon price is to align emissions management and financial strategies. By assigning a clear cost for each tonne of emissions, it’s easier to then determine the value of reducing and offsetting emissions.
Benefits of Using a Carbon Charge
In the case of a carbon charge, departments typically have a more direct financial incentive to reduce emissions. For example, if $10 million per year of the IT department’s budget goes toward internal carbon fees, and it costs $5 million to migrate to a net-zero data center that erases that internal carbon cost, that means investing in this emission reduction initiative would ultimately save the IT department $5 million.
Granted, these are departmental savings. The overall company is still technically spending the $5 million on the data center migration. However, the overall company benefits by achieving this emissions reduction. Those $10 million in internal carbon fee savings reflects that the company sees value in emissions management — whether that’s for supply chain purposes, compliance, public perception, etc.
Also, using a carbon charge helps different departments and employees throughout an organization take responsibility for their footprints. Instead of just a chief sustainability officer driving changes, for example, a carbon charge can make it more obvious and motivating for different stakeholders like marketing managers, procurement leads, and even HR staff (like when determining travel policies) to focus on reducing or offsetting emissions.
Moreover, carbon charges can fund carbon removals and other corporate sustainability initiatives. The reality is that not all emissions are likely to be cut right away, so if the IT department incurs, say, $10 million in carbon charges one year and $8 million the next, that’s $18 million that the overall company can earmark toward sustainability projects.
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Benefits of Using a Shadow Price
The benefits of using a shadow price are similar but more so centered around strategy than departmental savings. For example, finance departments can map out what would happen if local regulators implement a carbon tax of, say, $75 per tCO2e. By comparing what that would cost based on current emissions vs. possible future emissions paths, they can calculate potential savings and determine the value of reductions and offsets.
A shadow price could also be used to model supply chain changes. By assigning a value to emissions, companies focus on finding new suppliers or working with suppliers to redesign processes at a cost that comes in below whatever the internal carbon price is set at.
While it’s an imperfect science, as different organizations have different views on what an appropriate carbon price should be, the same could be said of many other financial strategies. For example, companies frequently weigh the cost/benefit of R&D — some might come to the conclusion that $1 invested in R&D yields $2 in revenue, while another might calculate that to be a $1:$3 ratio. Yet in either case, there’s no guarantee that the expected R&D costs and benefits will pan out.
Additional Advantages
Beyond the more direct financial reasons for setting an internal carbon price, there can be additional advantages, such as for reputational or voluntary compliance purposes.
For example, to become certified under The Climate Label — previously known as Climate Neutral Certified — companies have to set a Climate Transition Budget that helps fund their transition to net zero. As part of this, The Climate Label has established internal carbon fees that companies must use as at least a floor so that more money ultimately flows into value chain abatement and other projects such as carbon credits, in alignment with The Climate Label’s standards.
Examples of Internal Carbon Pricing
There are several examples of brands that have set internal carbon prices. Some of these include those that are part of The Climate Label, including well-known apparel brands like Allbirds and Vuori, as well as online platforms like Flickr and Kickstarter.
Beyond The Climate Label, some companies establish internal carbon pricing on their own accord.
For example, McKinsey started in 2023 by collecting a $50 per tCO2e on all air travel, which accounts for around 80% of the company’s overall emissions. In 2024, the company started collecting this carbon fee on all emissions and said it would increase the fee over time.
While that charge could incentivize more efficient air travel policies, for example, it also prompts the company to put more funding toward areas like carbon removals and purchasing sustainable aviation fuel. Instead of just generally trying to fund these areas, a carbon charge builds in clarity and accountability.
Swiss Re, a large reinsurance company, has also set aggressive internal carbon charges as part of its net-zero goals. The company started with what it calls a Carbon Steering Levy of $100 per tCO2e in 2021 and has been increasing that each year, with the plan to reach $200 per tonne in 2030. As the company notes, this fee helps the company “meet both our ‘Do our best’ and ‘remove the rest’ objectives” by incentivizing reductions and funding carbon removals.
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How to Get Started With Internal Carbon Pricing
Because internal carbon pricing is voluntary and largely subjective, there isn’t one particular way to get started. However, one approach could be to leverage the standards of certifying bodies like The Climate Label, whether or not you’re trying to get certified.
Also, consider recommendations such as from the Carbon Pricing Leadership Coalition (CPLC), which is administered by The World Bank. To limit temperature increases to 1.5ºC, the coalition’s High-level Commission on Carbon Prices recommends 2030 carbon prices of $226-$385 per tCO2e; and to keep temperatures well below 2ºC, they recommend 2030 rates of $63-$127 per tCO2e. Granted, these are geared toward external carbon prices set by regulators, but it could be a good indicator that many companies need to get more ambitious with their internal carbon pricing.
Companies also have to decide if they want to use a shadow price or an actual carbon charge. If using a shadow price, consider how that information could inform your strategy such as for capital management and emissions management. If using a carbon charge, the considerations are likely more complex, such as for determining where that funding comes from, how the program will be administered, and what you will put carbon fees toward.
If you’re looking for help establishing an internal carbon price or calculating your carbon footprint, Terrapass can help.
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