How Companies Set Internal Prices on Carbon

This post was co-authored with Elizabeth Medford

Despite the uncertainty created by the recent election, companies around the globe are demonstrating a commitment to keeping climate change in check. More than 300 American companies signed an open letter to President-elect Trump urging him not to abandon the Paris agreement. Others are acting on their own to reduce emissions in their daily operations, by setting an internal price on carbon.

The number of companies incorporating an internal carbon price into their business and investment decisions has reached new heights, a recent CDP report shows, with an increase of 23 percent over last year. The more than 1,200 companies that are currently using an internal carbon price (or are planning to within two years) are using them to determine which investments will be profitable and which will involve significant risk in the future, as carbon pricing programs are implemented around the world. Sometimes, they also use them to reach emissions reduction goals.

Not all carbon prices are created equal, and companies differ in how they set their specific price. Here’s a look at some of these methods:

Incorporating Carbon Prices from Existing Policies

 Some companies set their carbon price based on policies in the countries where they operate. For example, companies with operations in the European Union might decide to use a carbon price equal to that of the European Union Emissions Trading System (EU ETS) allowances, and those operating in the Northeastern United States might adopt the carbon price that results from the Regional Greenhouse Gas Initiative market.

ConocoPhillips, for example, focuses its internal carbon pricing practices on operations in countries with existing or imminent greenhouse gas (GHG) regulation. As a result, its carbon price ranges from $6-38 per metric ton depending on the country. For operations in countries without existing or imminent GHG regulation, projects costing $150 million or greater, or that results in 25,000 or more metric tons of carbon dioxide equivalent, must undergo a sensitivity analysis that includes carbon costs.

Using Self-Imposed Carbon Fees

Others take a more aggressive approach by setting a self-imposed carbon fee on energy use. This involves setting a fee on either units of carbon dioxide generated or a proxy measurement like energy use. These programs also often include a plan for using the fees such as investment in clean energy or energy efficiency measures. This can be an effective method for incentivizing more efficient operations.

Microsoft, for example, designed its own system to account for the price of its carbon emissions. The company pledged to make its operations carbon neutral in 2012 and does so through a “carbon fee,” which is calculated based on the costs of offsetting the company’s emissions through clean energy and efficiency initiatives. Each business group within Microsoft is responsible for paying the fee depending on how much energy it uses. Microsoft collects the fees in a “central carbon fee fund” used to subsidize investments in energy efficiency, green power, and carbon offsets projects. Still, by limiting carbon fees to operational activities, Microsoft has yet to address a large chunk of their emissions.

Setting Internal Carbon Prices to Reach Emissions Reduction Targets

 Other companies set an internal carbon price based on their self-adopted GHG emissions targets. This involves determining an emissions reduction goal and then back-calculating a carbon price that will ensure the company achieves its goal by the target date. This method is a broader approach focused more on significantly reducing emissions while also mitigating the potential future risk of carbon pricing policies.

Novartis, a Swiss-based global healthcare company, uses a carbon price of $100/tCO2 and cites potential climate change impacts as a motivator. The company has its own greenhouse gas emissions target, which it is using to cut emissions to half of its 2010 levels by 2030. These internal policies mean that Novartis, which is included in the European Union’s Emissions Trading Scheme (EU ETS), has been able to sell surplus allowances and thus far avoid an increase in operating costs.

Where we go from here

 While these internal carbon pricing activities are welcome – and we hope they continue – they are not sufficient to reduce greenhouse gases to the degree our nation or world requires. Like these forward thinking companies, nations around the world, including the United States, need to consider the costs of inaction, including the climate-related costs, to avoid short-sighted investments. Ultimately, we will need public policies that put a limit and a price on carbon throughout the economy.

The spread of internal carbon pricing could signal greater support for carbon pricing by governments. But companies can do more: the ultimate test of a company’s convictions and commitment to carbon pricing might be their willingness to advocate for well-designed, ambitious policies that achieve the reductions we need.

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Good news in California as carbon auction results improve, and carbon emissions continue falling

Co-authored by Erica Morehouse and Jonathan Camuzeaux (this post was originally posted in EDF Talks Global Climate).

While we hope President-elect Trump will listen to the almost unanimous global voice of governments and business leaders who all understand that we must act to avert catastrophic climate change, it’s indisputable that leadership from U.S. states will be of paramount importance. Amidst this chaos and uncertainty California and Quebec are now four years into a successful cap-and-trade program with shrinking carbon pollution footprints and thriving economies.

California and Quebec released results today from a much anticipated carbon auction that took place on November 15, and sold a greater number of allowances than in the past two auctions resulting in proceeds for the state Greenhouse Gas Reduction Fund.  This good news comes after California’s 2015 greenhouse gas reporting data earlier this month showed another year of carbon pollution decline for the Golden State.

These year-over-year pollution declines are the most important indicator of success.  But understandably the auction performance and amount raised for climate investment priorities will get a lot of attention in California, Quebec, and Ontario, which is slated to launch its own cap-and-trade program in January with linkage likely to California and Quebec in 2018.

Auction results see increased demand

The November 15 auction offered more than 87 million current vintage allowances (available for 2016 or later compliance) and sold almost 77 million. Approximately 10 million future allowances were offered that will not be available for use until 2019 or later; over one million of those allowances were sold.

These auction results represent a significant increase in demand from the August auction which offered a similar number and sold about 31 million allowances, up from a little over eight million allowances sold at the May auction, the first auction to experience very low demand for allowances.  The May and August auctions raised almost no revenue for the California Greenhouse Gas Reduction Fund (GGRF).  While final numbers won’t come in for another few weeks, based on the allowances sold, this auction likely raised over $360 million for the California GGRF. 

Impacts on demand for this auction

A number of factors, good and otherwise, contributed to this quarter’s results.

  1. One of the most immediate factors that likely contributed to increased demand in this auction is the knowledge that the minimum sale price or “floor price” will rise to about $13.50 in 2017. This is the last auction that participants will be able to purchase allowances for $12.73 before the annual increase.
  1. A constant during this and previous auctions is litigation brought by the California Chamber of Commerce and others challenging California’s cap-and-trade program design. The case was brought the day before California’s very first auction in 2012 and California won at the trial court level. The plaintiffs appealed, and the Court of Appeals will hear oral arguments on January 24, 2017. This outstanding litigation may be leading some potential auction participants to take a wait-and-see approach.
  1. This wait-and-see approach is only possible if regulated businesses in California already have enough allowances to cover their 2016 obligations. California just released preliminary data for 2015 which shows emissions were about 14 percent below the cap. This suggests a successful set of climate policies that are incentivizing polluters to lower levels of pollution below required levels if they are able.  Some have referred to this as an oversupply of allowances, but it’s perhaps more accurate to refer to it as over-compliance.  Businesses have a choice of how to respond when they over-comply: avoid buying allowances in a future auction or buy allowances when they are presumably cheaper and bank them for future use.

A big question is how much the passage of SB 32 in August has impacted auction demand.  Governor Brown had previously established a target of reducing carbon pollution 40 percent below 1990 levels by 2030 through an executive order, but SB 32 cemented this requirement into law making it much more certain.  Setting a 2030target could increase demand for allowances, but the market will not necessarily get certainty about that target or how California will meet it in one fell swoop.  While SB 32 set the 2030 target, like AB 32 it was silent on policy tools to meet that target so decisions about cap-and-trade post-2020 are still outstanding.

Greenhouse gas emissions decline again in 2015

California’s Mandatory Greenhouse Gas Reporting program requires that state’s largest polluters to report their emissions annually. The California Air Resources Board released the final tally of 2015 greenhouse gas emissions on November 4th, which showed yet another year of carbon pollution decrease.

In 2015, California’s emissions covered under the cap-and-trade program decreased by roughly one percent compared to the year before. California is on track to meet its target of reducing pollution to 1990 levels by 2020.  Carbon pollution for capped and uncapped sources was down in 2015.

Meanwhile, data from the Bureau of Economic Analysis shows the state’s gross domestic product increased by almost six percent in 2015 – while California also experienced an increase of total employment of a little over two percent in 2015 – proving again that economic output and emissions don’t necessarily go hand in hand.

With these results California is on solid footing to continue as a beacon of hope for climate action in the United States and perhaps even to attract new partners inside or outside the country who are ready to join a successful program.

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Ensuring Environmental Outcomes from a Carbon Tax

How can we ensure that a carbon tax delivers on its pollution reduction potential? An innovative, new idea could provide greater certainty over the environmental outcome.

As momentum intensifies around the world for action to fight climate change, the United States is emerging as a leader in the new low-carbon economy. But if we are going to reduce climate pollution at the pace and scale required — cutting emissions 26-28% below 2005 levels by 2025 and at least 83% by 2050, on a path to zero net emissions —we need to roll up our sleeves on a new generation of ambitious climate policies that harness the power of the economy and American innovation. An emerging idea could be a game-changer for the prospects of a carbon tax to help tackle climate pollution.

Economics 101 teaches us that market-based policies, including cap-and-trade programs as well as carbon taxes, are the most cost-effective and economically efficient means of achieving results. Both put a price on carbon emissions to reduce dangerous pollution. Cap-and-trade programs place a “cap” on the total quantity of allowable emissions, directly limiting pollution and ensuring a specific environmental result, while allowing prices to fluctuate as pollution permits are traded. The “guarantee” that the cap provides is a primary reason this tool has been favored by EDF and other stakeholders focused on environmental performance. That U.S. targets are based on quantities of pollution reductions also speaks to the need for policy solutions tied to these pollution limits.

In comparison, a carbon tax sets the price per unit of pollution, allowing emissions to respond to the changes in behavior this price encourages. The problem, from an environmental standpoint, is that a carbon tax lacks an explicit connection to a desired pollution reduction target — and therefore provides no assurance that the required reductions will actually be achieved. We know that a carbon tax will impact emissions, but even the most robust modeling cannot provide certainty over the magnitude of that impact. Furthermore, fundamental factors like energy or economic market dynamics can change over time, affecting the performance of a tax. Because greenhouse gas pollution accumulates in the atmosphere over time, even being slightly off the desired path over several decades can produce significant consequences for cumulative emissions, and thus climate damages.

A new approach: Environmental Integrity Mechanisms (EIMs)

Two recently-released papers by the Nicholas Institute at Duke University and Resources for the Future (RFF) directly address this key concern with a carbon tax —and suggest an innovative path forward. They illustrate how a suite of provisions – we’ll call them “Environmental Integrity Mechanisms” or “EIMs,” though each paper uses different terminology – could provide greater levels of certainty regarding the emissions outcome, by allowing for adjustment of the carbon tax regime over time to course-correct and keep us on track for meeting our targets.

EIMs – if carefully designed – can play an important role in connecting a carbon tax to its performance in reducing pollution. They are a type of built-in insurance mechanism: they may never be triggered if the initial price path achieves its projected impact, but provide a back-up plan in case it does not.

These mechanisms are analogous to well-studied “cost containment” provisions in cap-and-trade that are designed to provide greater certainty over prices. Cost containment provisions are included in several successful cap-and-trade programs around the world. For example, California’s cap-and-trade program includes a price collar that sets a floor as well as a ceiling that triggers the release of a reserve of allowances.

EIMs are a parallel effort to introduce greater emissions certainty into a carbon tax system. With the recent publication of these two papers, EIMS are beginning to receive well-deserved greater attention. These provisions help bridge the gap between caps and taxes, merging the strengths of each to create powerful hybrid programs.

How EIMs might work

Let’s take a closer look at how these “EIMs” could work.

• First, the initial tax level and/or growth rate could be adjusted depending on performance against an emissions trajectory or carbon budget benchmark. This could occur either automatically via a simple formula built into the legislation, by Congressional intervention at a later date based on expert recommendations, or by delegation of authority to a federal or independent agency or group of agencies.

There are clear advantages to including an automatic adjustment in the legislation. This avoids having to go back to a sluggish Congress to act; and there is no guarantee that Congress would make appropriate adjustments. Moreover, Congress is likely to be loath to relinquish its tax-setting authority to an executive agency — and such delegation could even face legal challenges. Delegating tax-setting authority to an executive agency could also introduce additional political uncertainty in rate setting.

In designing such an automatic adjustment, policy makers will need to consider the type, frequency and size of these adjustments, as well as how they are triggered. The RFF paper in particular discusses some of the resulting trade-offs. For example, an automatic adjustment will reduce the price certainty that many view as the core benefit of a tax. On the other hand, by explicitly and transparently specifying the adjustments that would occur under certain conditions, a high degree of price predictability can still be maintained – with the added benefit of increased emissions certainty.

• Second, the Nicholas Institute brief discusses regulatory tools that could be employed if emission goals were not met –including existing opportunities under the Clean Air Act, or even new authority. The authors point out that relative to automatic adjustment mechanisms, regulatory options are more difficult to “fine-tune.” Nevertheless, they could provide a powerful safeguard if alternatives fail.

• Finally, as the Nicholas Institute brief discusses, a portion of tax revenue could be used to fund additional reductions if performance goals were not being met. This approach could tap into cost-effective reductions in sectors where the carbon tax might be more challenging to implement (e.g. forestry or agriculture). The revenue could also be used to secure greater reductions from sectors covered by the tax — for example, by funding investments in energy efficiency. In a neat twist, the additional revenue needed to fund these emissions reductions would be available when emissions were higher than expected — that is, precisely when more mitigation was needed.

EDF’s take

Our goal is to reduce the amount of carbon pollution we put into the atmosphere in as cost-effective and efficient a manner as possible. This means putting a limit and a price on carbon pollution.

Even at this preliminary stage in the exploration of EIM design, one takeaway is clear: all carbon tax proposals should include an EIM with an automatic adjustment designed to meet the desired emissions path and associated carbon budget.

More work is needed to develop and evaluate the range and design of EIMs. And while a cap is still the most sure-fire means of guaranteeing an emissions outcome, this growing consideration by economists and policy experts opens a new path for the potential viability of carbon taxes as a pollution reduction tool in the United States.

The bottom line is this: The fundamental test of any climate policy is environmental integrity. For a carbon tax, that means an EIM.

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EDF-IETA maps show how the world can double down on carbon pricing

Carbon pricing

Currently, about 12% of the world's greenhouse gas emissions are covered by carbon pricing. More details about this map can be found in the Doubling Down on Carbon Pricing report by EDF and IETA.

There are a number of signs we are entering a golden age for carbon pricing. Perhaps the most important one is that many countries around the world are currently considering carbon pricing policies to achieve their greenhouse gas emissions reduction goals.

And for good reason.

A price on carbon gives emitters a powerful incentive to reduce emissions at the lowest possible cost, it promotes innovation while rewarding the development of even more cost-effective technologies, it drives private finance, and it can generate government revenue.

This spring, World Bank Group President Jim Yong Kim and International Monetary Fund Managing Director Christine Lagarde convened the Carbon Pricing Panel to urge countries and companies around the world to put a price on carbon. On April 21, 2016, the Panel announced the goals of doubling the amount of GHG emissions covered by carbon pricing mechanisms from current levels (about 12 percent, as illustrated in the map below) to 25 percent of global emissions by 2020, and doubling it again to 50 percent within the next decade.

EDF and the International Emissions Trading Association (IETA) worked together to explore a range of possible, though non-exhaustive, scenarios for meeting these goals. You can see the results in a series of maps which show how carbon pricing can be expanded worldwide.

Achieving the Carbon Pricing Panel’s goals will be a crucial stepping stone to realizing the ambition of the Paris Agreement, which aims to hold the increase in the global average temperature to well below 2°C above pre-industrial levels. Meeting that objective will require countries not only to implement the targets they have already announced, but to ratchet up their efforts dramatically in the years ahead. Carbon pricing will have to play a key role in that effort.

Explore how the world can reach the Carbon Pricing Panel’s ambitious goals.

This post originally appeared on Climate Talks.

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In Win for Environment, Court Recognizes Social Cost of Carbon

Co-authored with Martha Roberts

If someone was tallying up all the benefits of energy efficiency programs, you’d want them to include reducing climate pollution, right? That’s just common sense.

Thankfully, that’s what our government does when it designs energy efficiency programs—as well as other policies that impact greenhouse gas emissions. And just this month, this approach got an important seal of approval: For the first time, a federal court upheld using the social cost of carbon to inform vital protections against the harmful impacts of climate change.

So what is the social cost of carbon and why does it matter? It’s a crucial part of the development of climate safeguards and essential to our understanding of the full costs of climate pollution. We know that climate change is a clear and present danger now and for future generations—one that will result in enormous costs to our economy, human health and the environment. And yet, these “social” costs are not accounted for in our markets, and therefore in decision making. It is a classic Economics 101 market failure. Every ton of carbon dioxide pollution that is emitted when we burn fossil fuels to light our homes or drive our cars has a cost associated with it, a hidden one that is additional to what we pay on our utility bills or at the gas pump. These costs affect us all – and future generations – and are a result of the negative impacts of climate change. If we don’t recognize these hidden costs—we aren’t properly protecting ourselves against the dangers of climate pollution.

The social cost of carbon (or SCC) is an estimate of the total economic harm associated with emitting one additional ton of carbon dioxide pollution into the atmosphere. To reach the current estimate, several federal agencies came together to determine the range and central price point – roughly $40 per ton – through a transparent and rigorous interagency process that was based on the latest peer-reviewed science and economics available, and which allowed for repeated public comments.

It’s critical that we protect against the damages and costs caused by climate pollution. So it’s a no-brainer that when considering the costs and benefits of climate safeguards, we must take into account all benefits and costs – and that means including the social cost of carbon.

In their court opinion, the Federal Court of Appeals for the Seventh Circuit agreed wholeheartedly. Harvard Law Professor Cass Sunstein noted that their decision “upholds a foundation” of “countless” climate protections. In particular, their opinion made two important findings:

  • First, the court affirmed that the DOE was correct to include a value for the social cost of carbon in its analysis. The judges concluded that “[w]e have no doubt” that Congress intended for DOE to have authority to consider the social cost of carbon. Importantly, this conclusion reinforces the appropriateness of including the SCC in future carbon-related rule-makings.
  • Second, the court upheld key choices about how the SCC estimate was calculated. The court agreed that DOE properly considered all impacts of climate change, even those years from now, or outside our borders. These choices, the court concluded, were reasonable and appropriate given the nature of the climate crisis we face.

DOE itself acknowledged “limitations in the SCC estimates.” We couldn’t agree more. As new and better information about the impacts of climate change becomes available and as our ability to translate this science into economic impacts improves, regulators must update the current social cost of carbon estimate. There is still much we do not know about the full magnitude of climate impacts and much that cannot be quantified (as is true of all economic impact analysis) – which means that SCC estimates are likely far lower than the true impact of climate change. But as the Seventh Circuit recognized, their inclusion is a vital step in the right direction for sensible policy-making.

This decision already has positive implications more broadly—in particular, for the Clean Power Plan, our nation’s historic program to reduce carbon pollution from power plants. Just last week, EPA submitted a letter in the Clean Power Plan litigation noting that the Seventh Circuit’s decision further demonstrates the error of challenges to the treatment of costs and benefits in the Clean Power Plan rulemaking. It’s just another affirmation of the rock-solid legal and technical foundation for the Clean Power Plan.

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How More Transparent Electricity Pricing Can Help Increase Clean Energy

By: Beia Spiller and Kristina Mohlin

The price of most goods we purchase is CostPriceImagegenerally based on the costs associated with the goods' production, including the raw materials used to generate them, the labor associated with their manufacturing, and so on. However, when it comes to pricing residential electricity, many regulators choose to use a flat price per unit of electricity (kilowatt-hours, or kWh) that unfortunately fails to adequately reflect the underlying costs of generating and delivering energy to our homes.

This creates incorrect incentives for conservation and investments in distributed energy resources (like rooftop solar, energy storage, and demand response). Getting these incentives right can go a long way in creating more opportunity for efficiency and clean energy resources.

Pricing electricity generation

The cost of generating electricity from large-scale power plants varies significantly over the course of a day. When demand is low, electricity providers call upon the most efficient and inexpensive power plants to produce electricity. As demand increases, they must also utilize more inefficient and expensive power plants. So, for the price of generation to accurately reflect these costs, it too must vary with the time of day. Time-variant pricing charges customers more for using electricity during periods of high demand (such as during hot afternoons) and less when demand is not as great. This pricing system is an accurate reflection of generation costs.

In contrast, flat rates that don’t vary over time incentivize customers to consume more electricity when it’s most valuable to them, even though consuming during times of high demand places a larger cost on the system. Thus, the current, static pricing system creates incorrect incentives for conservation and electricity use. Read More »

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