Prime Numbers: Internal carbon pricing is on the rise, but needs to rise higher

It’s encouraging to see a growing number of businesses committing to ambitious climate targets. More than 25 percent of S&P 500 companies have pledged to align their practices with Paris Agreement goals and two-thirds have targets for greenhouse gas emissions. To galvanize action, organizations are increasingly embracing internal carbon pricing (ICP): placing a financial value on their carbon emissions to create incentives for sustainable business practices.

Two years ago, we summarized the state of internal carbon pricing based on 2019 data, revealing growing interest but high variability in companies’ use of these internal charges. We recently studied how those patterns changed over the subsequent two years, using the most recent available data (Exhibit 1). In both cases, our dataset comprised the top 100 companies by revenue in each sector.

Internal carbon pricing is most prevalent in energy, materials, and tech, media, and telecom sectors; use increased about ten percentage points since 2019.

The analysis indicates increasing use of ICP across industries, with nine sectors showing an average increase of 10 percent or more between 2019 and 2021. However, there is room for significant improvement, particularly in high-emissions industries. In the industrials sector, for example, use of ICP has grown by 12 percent, but that still covers only 38 percent of the top 100 companies. In the energy and materials sectors, which together account for approximately 60 percent of global CO2 emissions, 50 percent or fewer of the largest companies have embraced ICP.

Even if ICP adoption were to grow at 5 percent per year, it would take the energy sector (the biggest adopter) a decade to achieve full ICP coverage, and 20 years for the healthcare sector, which has the lowest adoption rate of the 13 industries we studied. That pace won’t get us to the net-zero targets.

Additionally, while the internal carbon prices are rising, they remain far below the guidance set out in the Intergovernmental Panel on Climate Change (IPCC) 2022 report. Even in industrials, the sector with the highest share of companies whose carbon pricing is within the range needed to meet IPCC targets, only 13 percent of companies clear the bar.

In the three sectors with the highest ICP adoption—energy; materials; and tech, media, and telecom (TMT)—fewer than 5 percent of the organizations with carbon-pricing strategies price emissions at rates that align with Paris Agreement goals. Energy and materials sectors lead the way, with a median internal carbon charge of $50 per metric ton, while the insurance sector has the lowest median price, at a mere 10 cents per metric ton (Exhibit 2).

Median internal carbon prices across all sectors are below the range needed to meet Paris Agreement emissions targets by 2030.

The use of internal carbon charges also varies widely by region. In Europe, where ICP is most prevalent, 40 percent of large companies use this approach to promote sustainability. The EU Emissions Trading System (ETS) also has higher prices than other regions, although only 40 percent of European companies with ICP have internal charges exceeding the current ETS price of $87 per metric ton. In contrast, only 26 percent of Asian companies and 17 percent of American companies have implemented ICP.

Adoption and pricing levels aren’t the only challenges associated with ICP. Companies also look at limited scopes. Most ICP schemes address solely scope 1 and 2 emissions despite the fact that scope 3 accounts for more than half of total emissions and is increasingly included in decarbonization goals. The TMT and industrials sectors have the largest disparity, at 70 percent, between the share of sector emissions that fall into scope 3 and the portion of companies that address scope 3 in their ICP (Exhibit 3). Even in the energy and materials sectors, where ICP is most broadly embraced, only a quarter or less of scope 3 emissions are covered by ICP, even though these emissions account for up to 70 percent of the sectors’ totals.

While more than 50 percent of total emissions stems from Scope 3 emissions across sectors, internal carbon price coverage on Scope 3 is limited.

While the growing popularity of internal carbon pricing is heartening, the adoption rate, prices, and scope coverage need to rise significantly if companies are to meet their climate commitments. Businesses that embrace ICP and implement it robustly may find that it not only helps them make informed investment decisions but demonstrates a commitment to climate action that may inspire others to do likewise.

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Werner Rehm is a partner in McKinsey’s New Jersey office, Adela Kim is a solution associate in the Dallas office, Ewa Granosik is a solution associate in the Warsaw office, and Donatela Bellone is a solution associate partner in the Phoenix office.

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