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Internal Carbon Pricing: A Critical Tool for Businesses to Achieve Net Zero Emissions

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Climate change is a significant challenge facing the world, and the root cause is the warming effect caused by the continuous increase in greenhouse gas emissions from fuel energy uses. As one of the main sources of greenhouse gas emissions, businesses should play an indispensable role in global climate action.

According to the 2023 World Economic Forum (WEF), the impact of climate change on the global economy and society is considered one of the top 10 risks. Moreover, in response to the 2050 net zero target, countries around the world have set carbon policy goals and introduced carbon management policies, such as carbon taxes/fees and emission trade system, with the aim of reducing domestic carbon emissions. Clear and well-intentioned compliance carbon policies will bring negative financial impacts to business operation. How to reduce the financial impacts of carbon policies on business operations, manage carbon risks, and invest in innovative carbon reduction technologies has become a top priority for businesses in their global climate actions.

Carbon is produced in different manufacturing processes of products and is a co-product of product production or energy use. Throughout the product life cycle, from raw material extraction to product disposal, carbon continuously flows and accumulates. Therefore, the purpose of governments' carbon management policies is to consider linking the carbon flow and cash flow of businesses, using carbon regulation policies to have a substantive impact on the businesses' cash flow, thereby reducing their incentive to emit carbon.

The World Bank defines carbon pricing mechanism as "a mechanism that translates the various damages caused by carbon emissions to the environment and society into monetary values and links them to emissions behavior." The mechanisms can be classified into regional, national, or corporate levels, depending on the implementing entity.

Internal Carbon Pricing (ICP) refers to the mechanism of implementing carbon pricing within a company. Although ICP is voluntary, it stems from the government's implementation of carbon pricing, and businesses adopt ICP to reduce the impact of national carbon pricing in advance.

In recent years, more and more businesses have viewed ICP as an important tool for driving carbon reduction. According to CDP, nearly half (226) of the world's top 500 companies have adopted ICP. Additionally, among all companies, more than 2,000 have disclosed to CDP that they are currently using (853) or plan to use (1,159) carbon pricing within the next two years. Nearly 61% of these companies that have implemented or plan to implement ICP believe it will drive low-carbon investment incentives internally, 58% believe it can improve energy efficiency, and 55% believe it can reduce carbon costs by changing internal practices, demonstrating that ICP is indeed a powerful tool for businesses to implement carbon reduction.

From a theoretical perspective, ICP can be divided into three types: implied pricing, shadow pricing, and internal carbon fee.

  • Implied pricing: a company calculating the average cost of emissions reduction based on past investment in various reduction projects, and using this as the cost burden for similar future projects.
  • Shadow pricing: incorporating an external carbon price into operations as a reference for business decision-making. The key characteristic of shadow pricing is that it does not involve actual cash flow changes.  It is a method to assess the potential impact on business decisions if the cost of carbon emissions were included.
  • Internal carbon fee: the actual payment of a carbon fee based on a company's internal emissions, providing internal units with a clear price signal for carbon reduction and motivating them to make low-carbon investments or take carbon reduction actions. However, since it involves actual fee collection, it might lead to resistance or challenges within the company, making implementation difficult.

In practice, when implementing ICP, companies first need to set a carbon price, typically referencing external carbon trading market prices. These external price references are numerous and mainly depend on the company's carbon reduction goals. For instance, if a company wants to establish ICP for its global operations, it can refer to the social costs provided by the World Bank or the International Energy Agency (IEA) for achieving net zero by 2030, which is approximately $100 per ton of carbon equivalent. If setting a carbon price for a specific country or region, companies can benchmark against the local national carbon price or renewable energy electricity market price. Take EU ETS as an example, the price is around $80 per ton. If the purpose is for voluntary carbon offsetting investments or purchases, companies can refer to the prices of nature-based carbon sinks or carbon removal technologies, which are typically above $20 per ton.

Microsoft began implementing ICP in 2012 and raised the rate to $15 per ton of carbon emissions in 2019, covering the company's Scope 1, 2, and 3 greenhouse gas emissions across more than 100 countries.

Microsoft's carbon pricing methodology is based on the environmental advocacy cost ((internal reduction cost + clean energy procurement or investment cost + carbon credit offset cost) / emissions during a specific period). The collected carbon fee revenue is used as one of the sources for the company's carbon removal innovation fund, which will be invested in carbon removal technologies including afforestation, biochar, direct air capture (DAC), and the purchase of derived carbon credits.

Among Taiwanese companies, Delta Electronics was one of the earliest to implement ICP in two phases. The first phase involved shadow pricing, incorporating the carbon price into internal operational decisions to incentivize investment in low-carbon processes by internal units. The second phase adopted an internal carbon fee, actually charging internal units $300 per ton and using the revenue to replace old and energy-intensive equipment, procure renewable energy, and invest in innovative carbon reduction technologies. In addition to Delta, major Taiwanese companies such as TSMC, AUO, and ASE have also implemented ICP mechanisms and used shadow carbon pricing to drive internal carbon reduction actions.

Starting from 2023, ASUS has viewed ICP as one of the necessary tools to achieve its 2050 net zero target, implement the Science Based Targets (SBT) and meet the RE100 commitment. ASUS referred to the decisions of the United Nations Climate Change Conference (COP) and relevant official documents from the IPCC, analyzed the principles of various compliance carbon pricing mechanisms, and considered the EU ETS as the global ETS benchmark. Therefore, ASUS's ICP design is based on the EU Carbon Border Adjustment Mechanism (CBAM) and the EU ETS prcing. Following the EU ETS free allowance calculation method, which first calculates using the industry benchmark approach and then allocates based on the import share, ASUS sets the ICP for its major products at $80 per ton of CO2e for emissions exceeding the allocated import share. The performance of ASUS's ICP will be disclosed in its 2023 internal report, providing a reference for business units to track and manage carbon reduction performance.

From ASUS's experience in implementing ICP, potential challenges for businesses include:

  1. Incomplete and poor-quality carbon data: Accurately calculating greenhouse gas emissions is crucial for setting ICP. Completeness and reliability of data quality will help companies set ambitious carbon prices for reduction.
  2. Difficulty in defining the scope of application: Companies with diverse product lines face different customer groups, profitability levels and long supply chains, which suppliers may vary in carbon reduction capabilities. Balancing the concerns of different stakeholders and carbon reduction commitments is a challenge for companies.
  3. Appropriate carbon price: If the internal carbon price is too low, it may not effectively guide BUs carbon reduction behavior and fail to serve its purpose. If it is too high, it may lead to BUs backlash.

As the timeline for businesses' carbon reduction commitments draws closer, ICP will undoubtedly become an important milestone towards their low-carbon transformation, not only better managing their carbon footprint but also actively seizing business opportunities arising from the low-carbon economy.

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