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Carbon pricing explained: Taxes, trading systems and internal business practices

What is carbon pricing?

Carbon pricing is a policy approach used to put a price on greenhouse gas (GHG) emissions. It is a mechanism that aims to create economic incentives for emitters (whether individuals, businesses or governments), to reduce their carbon footprint, and ultimately contribute to global efforts to mitigate climate change.

There are two primary methods of implementing carbon pricing: Carbon taxes and Emissions Trading Systems (ETS).

Diagram showing different types of carbon pricing

Carbon pricing is a global phenomenon

Carbon pricing has gained global recognition as an effective tool for addressing climate change. There are over 60 direct carbon pricing instruments operating in more than 45 national jurisdictions around the world. These comprise of both carbon tax regimes and ETSs.

Examples include:

  • The UK ETS, which applies to energy intensive industries, the aviation sector and the power generation sector. 

  • The EU ETS, which is mandatory for companies in sectors like electricity and heat generation, energy-intensive industries (oil refineries, steel works, material production), aviation and maritime transport. 

  • The Regional Greenhouse Gas Initiative (RGGI) is the first mandatory ETS in the US. It was launched in 2009 and covers twelve states, including California.

  • The Greenhouse Gas Pollution Pricing Act is a carbon tax that covers every jurisdiction in Canada.

Why does carbon pricing matter for businesses?

Carbon pricing mainly has direct impacts on high-emitting industries at the moment, influencing their operations and strategies. But, in most cases, the introduction of a carbon price leads to the cost of fossil fuel energy and other carbon-intensive goods and services increasing due to higher energy prices.

So, although there isn't an immediate ‘to do’ for many businesses, as fossil fuels inevitably become less attractive economically going forward, shifting to lower carbon alternatives and decarbonising operations now can help build resilience in the future.

Companies can help mitigate the financial impact of carbon pricing by carrying our effective carbon management, investing in energy-efficient technologies, adopting cleaner production methods and optimising their supply chains.

Carbon accounting can prepare businesses for carbon pricing

Businesses that are heavy emitters or rely heavily on carbon-intensive processes may experience increased operational costs due to purchasing emissions allowances or paying carbon taxes. This can in turn make production more expensive and reduce the demand for carbon-intensive products.

Businesses subject to carbon pricing need to measure, manage and report on their carbon emissions. This requirement of emissions data means companies must develop robust carbon accounting systems.

Effective carbon accounting is vital for any business looking to reduce their emissions because it helps them understand their carbon footprint, identify emissions hotspots and integrate data-driven carbon action plans in line with wider business goals.

Manual carbon accounting for businesses can be tricky though, particularly those with complex supply chains. Top tip is to utilise technology and software wherever possible to help save time and resources.

Internal carbon pricing is an effective carbon reduction strategy

In addition, internal carbon pricing can be used as a strategic business practice to reduce GHGs. This is where a company assigns a monetary value to carbon emissions as part of its internal decision-making processes.

Although internal carbon pricing is voluntary and not necessarily tied to regulatory requirements, as governments around the world implement policies to address climate change, companies that have already integrated internal carbon pricing into their operations may find themselves better prepared to navigate evolving carbon-related regulations and market dynamics.

How does internal carbon pricing work?

1. Assigning a carbon price

The company sets an internal price per unit (tonnes) of carbon dioxide equivalent (CO2e) emissions. This price can be determined based on various factors, such as the anticipated cost of future carbon regulations, the social cost of carbon (an estimate of the economic damages caused by each additional tonne of CO2e emissions), or the company's own sustainability goals.

2. Emissions assessment

The company assesses its carbon emissions across its operations, supply chain and other relevant activities. This includes measuring emissions from energy use, transportation, manufacturing and other sources.

3. Cost calculation

The company calculates the cost of its emissions by multiplying the total emissions by the internal carbon price per tonne. This results in a "carbon cost" for the organisation.

4. Integration into decision-making

The calculated carbon cost is integrated into the company's decision-making processes. For example, it may be factored into investment decisions for new projects, energy efficiency initiatives or supply chain optimisation. Companies may also use it to set emissions reduction targets.

5. Reporting and transparency

Many organisations choose to disclose their internal carbon pricing efforts in sustainability reports or financial disclosures to enhance transparency and demonstrate their commitment to addressing climate change.

Reach out to our team if you would like to find out more about how carbon pricing could affect your business or how to get started with your carbon accounting.


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