October19 , 2021

    Internal carbon pricing: Pivoting corporate voluntary actions towards net-zero

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    MUMBAI, INDIA. As the days to Glasgow Climate Change Conference COP 26 is coming closer, trumpeting of uber green credentials and carbon neutrality pledges by companies is increasingly getting shriller. Given ostensibly low interest shown by corporate leaders in addressing climate related risks all along, the sudden shift adds a bit of curiosity. All these years a misplaced thinking prevailed in corporate boardrooms– as it is not a concerning issue requiring resolution in the immediate quarter or the quarter next – rather it can be silently deferred far away in the future.

    Amid trails of reassuring pronouncements, it is only time would tell as to what extent and by what timeline these open ended pledges would get translated into tangible actions towards mitigation of climate risks. Concomitantly, severity of the burning climate change issues demand serious directional steps by the companies to assimilate behavioral change and voluntary actions towards emission reduction commitments. Effective handling of climate related transition risks and opportunities necessitate urgent adoption of carbon pricing policies accounting true social costs of emissions arising from their business operations. 

    Can we continue looking the other way for any longer?

    Task Force on Climate-related Financial Disclosures (TCFD) framework of recommendations highlighted Internal Carbon Pricing (ICP) as a critical forward-looking internal planning tool for the organizations to manage climate risks. Guiding capital investment decisions, it can effectively help corporations to identify revenue opportunities and risks along with incentives to drive energy efficiencies and reduction in costs. After passage of more than 4 years of TCFD recommendations, corporate voluntary actions relating to formulation of carbon policies and adoption of ICP in internal decision-making show an overall sloppy progress trend. Per CDP India Annual Report 2020, out of 220 companies disclosing through CDP – only 25 companies indicated practicing ICP in corporate decisions and another 33 companies planning to adopt in next 2 years. In absence of stringent universal regulatory measures, the phenomenon could be attributed to low corporate interest levels along with inhibition to commit for changes entailing capital and cost implications. At the same time, Hindustan Zinc Limited, IndusInd Bank, Mahindra & Mahindra and Tech Mahindra finding place in CDP A List as climate leaders – being the first for Indian companies, sets an encouraging tone for the coming period.

    Making a beginning with a small baby step

    As a part of India CEO Forum on Climate Change in Nov 2020, leaders from key industry sectors came forward to support government efforts in fighting climate change towards achieving India’s NDC goals. Pledging to create a low-carbon sustainable economy with increased levels of voluntary actions, a ‘Declaration on Climate Change’ was signed by leading private companies in partnership with the Ministry of Environment, Forest and Climate Change. To move towards net zero targets, the private sector considered establishing realistic emissions reduction and energy efficiency goals and achievable voluntary targets in their companies. After a long period of silence and reticence, growing realization amongst the private sector about their willing role and voluntary contributions towards net zero economy goals bolsters a new level of hope.

    Is putting carbon price in any form just good enough?

    In coming weeks, while governments negotiate for a global consensus on broad architecture of market and non-market based approaches mechanism under unsettled Article 6 of the Paris Agreement in COP26, the focus shifts back on the long debated issue of ‘carbon pricing’. Complementing climate policies for sustained emission reductions, a robust carbon pricing mechanism can effectively play a vital role in driving emission reductions with incentives to move for efficient and cleaner alternatives. The High-Level Commission on Carbon Prices report by eminent economists in 2017 emphasized that setting a strong carbon price becomes important for countries to realize world’s climate goals in the most cost-effective way while balancing growth imperatives. It also indicated the range of prices – a goal to reach $40-$80 per ton of CO2 by 2020 and $50-100 per ton by 2030. 

    In absence of a harmonized market led mechanism, evolution of standardized and reliable carbon pricing is yet to emerge. Thus, much is left on the discretion of individual companies for the type of ICP applied – i.e. shadow price, implicit price, internal trading/offsetting or carbon fee as well as subjective basis for putting a price to carbon unit per their ambition of SBT targets. To reflect on ICP disclosed by Indian companies in CDP India Annual Report 2020, both pricing and type of ICP applied have been quite varied. For example, it indicated a wide range of ICP from $4.48 under offsets (Tata Consumer Products Ltd.) to $50.11 under shadow price (Wipro).

    Too much on the plate for focused planning and implementation

    Inducing a shift from traditional thinking, ICP guides companies to holistically evaluate climate-related risks and opportunities aligned to their business strategies and formulate credible steps towards net-zero emission. With adoption of transparent measures to attribute a financial cost to carbon footprint created by them, corporations can realistically analyze materiality of transition risks and opportunities in their business ecosystem. Below are priority focus areas for development of industry or segment centric contextualized metrics to support corporate decision-making and risk management paradigm towards realization of sustainable business architecture:

    • Capital budgeting decisions: Capital investment decisions for Greenfield or Brownfield projects require reckoning of true economic costs relating to emission levels, energy efficiency, natural resources usage and social impacts to communities and ecosystems. Extending the traditional metrics of financial return based thresholds, the reformulated business case evaluation model prioritizes capital and resources allocation to low-carbon, energy efficient and green technology alternatives. In a larger context, the carbon pricing concept becomes a critical imperative of the credit appraisal process for the banks and financial institutions to extend project financing and loans. 
    • Risk Management: Besides traditional risk dimensions, incorporating risk scenarios relating to climate change and likely disruption of production and business revenues or entailing additional or new costs in risk mitigations become a critical requisite. Integrating core nuances of non-conventional risk dimensions, recalibrated risk modelling and scenario analysis must rely on true economic costs of climate risks and impacts.
    • Business operations: A comprehensive analysis of operational costs, risks and opportunities based on a forward-looking framework to incentivize low-carbon strategy and dis-incentivizing carbon-intensive practices would provide a significant impetus.
    • OPEX: Direct costs to business operations to change conventional behaviors and practices inducing negative impacts to the environment:
    • Greenhouse gas emissions, effluent and landfills 
    • Reduction of natural resources usage – i.e. water, land usage, reclamation, deforestation
    • Incentives: Direct incentives to business operations to encourage behaviors and practices beneficial for the environment:
    • Efficient waste management enabling recycle and reuse 
    • Improving energy efficiency, development and usage of renewable energy
    • Biodiversity conservation, afforestation, water conservation and recharge of aquatic sources
    • Research and innovation: Incentivizing research and development investment to identify of green revenues opportunities to reduce reliance on carbon-intensive business:
    • Product innovation and greener business pursuits
    • Production process related improvements by adapting low carbon technology alternatives and energy efficient solutions
    • Business partners and ecosystem influence: Establishing incentives and penalties to promote sustainable actions and behaviors by third parties involved in the supply chain – who are under direct influence of business firm:
    • Reducing carbon footprint in integration of raw material suppliers, supply chain partners, dealers and service providers
    • Promoting green packaging, recycling and sustainable disposal of waste / packaging materials and safe handling of non-bio degradable materials

    Continued inaction by corporations aggravates the climate risks and impacts with each passing day. Comprehensive integration of climate risks materiality evaluation and carbon pricing based consideration of explicit costs, impacts and sustainable alternatives becomes a vital tool for realization of reliable transition strategies.

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