Carbon pricing refers to mechanisms that incentivise a shift towards a low-carbon economy by putting a price on greenhouse gas (GHG) emissions (UNFCCC n.d.; World Bank 2022). Carbon pricing instruments can take many forms, but these can be broadly divided into two categories – governmental carbon prices and internal carbon prices (set internally by corporates themselves).
Figure 1: Categories of carbon pricing
Source: CEEW-CEF compilation based on UNESCAP (2020), ADB (2021), and World Bank (2022)
Governmental carbon prices can be implemented using various policy instruments, which are further categorised into explicit or direct carbon pricing and implicit or indirect carbon pricing. The former refers to policy measures explicitly imposing a price per unit of GHG emissions (European Parliamentary Research Service 2020; World Bank 2022). These usually take the form of carbon taxes and emissions trading systems (ETS) (Asian Development Bank 2021; World Bank 2021). The cost of carbon is determined either by a regulator (carbon tax) or the market (emissions trading systems). Please refer to the CEF Explains article on “Carbon Pricing” for more details. In implicit/indirect carbon pricing, policy instruments such as efficiency standards, subsidies, and fossil fuel taxes are used to indirectly assign a cost to carbon emissions (European Parliamentary Research Service 2020; UNEP FI 2022; World Bank 2022). However, this article will focus on Internal Carbon Pricing (ICP).
ICP is a cost voluntarily attached by businesses to their own GHG emissions to internalise climate risks in their investment decisions (Energy Studies Institute 2022; UN Global Compact Network 2018; World Bank 2019). It has the potential to aid in low-carbon transitions by directing investments toward clean technologies (CDP and CPLC n.d.). The UN Economic and Social Commission for Asia and the Pacific (UNESCAP) outlines four broad categories of ICP (UNESCAP 2020).
- Shadow pricing: A shadow price is a hypothetical cost assigned to each ton of carbon emissions to account for the climate risks in a business (World Bank 2021). It is used to assess business cases, procedures, and strategies to understand how emission costs impact businesses (ibid). Financial institutions may use it to make credit allocation decisions in favour of low-carbon businesses. In contrast, businesses could use it to assess the carbon-adjusted future profitability of a project.
- Implicit pricing: An implicit carbon price is an ex-post measure calculated based on the emissions abatement achieved by an existing project(s) and the cost associated with the same (WRI, 2018). This cost could be the investment associated with the cumulative emissions abatement achieved (ibid). Alternatively, companies sometimes determine implicit carbon prices based on the cost of carbon offsets purchased (ibid). This price is used while making new investment decisions (World Bank 2021; WRI 2018).
- Internal carbon tax/fee: An internal carbon tax/fee is a fee per tonne of carbon dioxide (tCO2) imposed on organisation-wide emissions (Center for Climate and Energy Solutions n.d.; WRI 2018). The revenue stream generated from the internal carbon tax is then used for financing low-carbon projects and activities (World Bank 2021; WRI 2018).
- Internal trading mechanisms: Internal trading mechanisms replicate external emissions trading systems such as the European Union ETS. The organisation sets a cap on the carbon emissions from each business unit, creates allowances, and allows the business units to buy or sell these allowances with each other (UNESCAP 2020; WRI 2018).
Incidence of ICP
In 2021, 1077 companies worldwide and 31 companies in India reported using ICP (CDP and CPLC n.d.). Mahindra and Mahindra was the first Indian company to use ICP in 2016 (Aggarwal 2016). Afterwards, many other companies, such as UltraTech Cement Ltd. and JSW Energy (CDP and CPLC n.d.), announced ICP’s application in their businesses.
As reported by several organisations, ICP exhibits considerable variability, ranging from USD 6 to 918 per tonne of carbon dioxide equivalent (tCO2) (World Bank 2021). Since there are no universal guidelines on carbon pricing, and each company sets its own price depending on its own local context, the ICPs of organisations vary greatly (Energy Studies Institute 2022).
Who should care?
-  Aggarwal, Mayank. 2016. “Mahindra Announces Internal Carbon Price of $10 Per Tonne of Emissions.” Live Mint. https://www.livemint.com/Companies/4i1kgS45VZiiNIHuO1mWFN/Mahindra-announces-internal-carbon-price-of-10-per-tonne-of.html
-  Asian Development Bank. 2021. “Carbon Pricing.” Asian Development Bank. https://www.adb.org/sites/default/files/institutional-document/691951/ado2021bn-carbon-pricing-developing-asia.pdf
-  Center for Climate and Energy Solutions. n.d. “Internal Carbon Pricing.” Accessed on December 16, 2022. https://www.c2es.org/content/internal-carbon-pricing/
-  CDP and CPLC. n.d. “What Is Internal Carbon Pricing and How Can It Help Achieve Your Net-zero Goal?” Carbon Disclosure Project and Carbon Pricing Leadership Coalition. Accessed on December 16, 2022. https://cdn.cdp.net/cdp-production/cms/reports/documents/000/006/374/original/ICP_White_paper_Final_%281%29.pdf?1653572442
-  Energy Studies Institute. 2022. “Corporate Internal Carbon Pricing: Global Trends and Challenges.” Energy Studies Institute, National University of Singapore. https://esi.nus.edu.sg/docs/default-source/esi-policy-briefs/corporate-internal-carbon-pricing_global-trends-and-challenges.pdf
-  European Parliamentary Research Service. 2020. “Carbon Emissions Pricing: Some Points of Reference.” European Parliament. https://www.europarl.europa.eu/thinktank/en/document/EPRS_BRI(2020)649352
-  UN Global Compact Network. 2018. “Internal Carbon Pricing in Companies.” UN Global Compact Network. https://www.unglobalcompact.org/library/5653
-  UNEP FI. 2022. “Position Paper on Governmental Carbon Pricing.” United Nations Environment Programme Finance Initiative. https://www.unepfi.org/wordpress/wp-content/uploads/2022/06/NZAOA_Governmental-Carbon-Pricing.pdf
-  UNESCAP. 2020. “Businesses Move Forward with Carbon Pricing.” United Nations Economic and Social Commission for Asia and the Pacific. https://www.unescap.org/sites/default/d8files/knowledge-products/xPB109_Businesses%20move%20forward%20with%20carbon%20pricing.pdf
-  UNFCCC. N.d. “About Carbon Pricing.” United Nations Framework Convention on Climate Change. Accessed on December 16, 2022. https://unfccc.int/about-us/regional-collaboration-centres/the-ciaca/about-carbon-pricing#What-is-Carbon-Pricing?-
-  World Bank. 2019. “State and Trends of Carbon Pricing 2019.” World Bank Group. https://openknowledge.worldbank.org/entities/publication/0a107aa7-dcc8-5619-bdcf-71f97a8909d6
-  World Bank. 2021. “State and Trends of Carbon Pricing 2021.” World Bank Group. https://openknowledge.worldbank.org/entities/publication/7d8bfbd4-ee50-51d7-ac80-f3e28623311d
-  World Bank. 2022. “State and Trends of Carbon Pricing 2022.” World Bank Group. https://openknowledge.worldbank.org/handle/10986/37455
-  WRI. 2018. “4 Ways Companies Can Price Carbon: Lessons from India.” World Resources Institute. Accessed on December 16, 2022. https://www.wri.org/insights/4-ways-companies-can-price-carbon-lessons-india
CEF Analysis” is a product of the CEEW Centre for Energy Finance, explaining real-time market developments based on publicly available data and engagements with market participants. By their very nature, these pieces are not peer-reviewed. CEEW-CEF and CEEW assume no legal responsibility or financial liability for the omissions, errors, and inaccuracies in the analysis.