15 May 2023

To slow down global warming and reduce greenhouse gas emissions, several mechanisms currently exist, including carbon compliance markets. While this strategy has proven successful, it will not be enough to achieve the zero-carbon target between 2050 and 2070. To achieve this, companies must adopt a responsible financial strategy and steer decarbonization action using two tools: the internal carbon price and climate dividends.

Pierre-Emmanuel GUILHEMSANS-VENDÉ, R&D Consultant at TNP Consultants. 

Compliance markets: how it works?

The first carbon compliance markets appeared in Finland and Poland after the first IPC Creport in 1990. Following the ratification of the Kyoto Protocol in 2005 by at least 55 parties representing at least 55% of GHG emissions (192 parties today), the largest compliance market of the time was created, the European Union Emissions Trading System (EU ETS). This market still represents the benchmark for carbon compliance markets, although since February 2021, China, representing 29% of global GHG emissions, has become the largest market. More globally, there are 68 carbon compliance markets in the world, covering 11.83 Gt CO2e, or 23.11% of global GHG emissions. Compliance markets apply three methods to ensure that GHG emissions are reduced:

• Setting an emissions cap (the allowance market): the 15,000 stationary installations and 1,500 aircraft operators in the European allowance market cover 45% of European greenhouse gas emissions and each have a cap of allowances to meet that is expected to decrease each year. Companies can trade or borrow allowances to avoid exceeding the set limit and be penalized financially (€100 + inflation per ton of CO2e in excess, i.e. €116/ton CO2e in 2022). They can also save or resell unused allowances.
• Taxation: carbon taxes are managed at national level. In France, this is the domestic consumption tax on energy products: it constitutes 40% of the price of fuel.
• Offsetting: this is the financing of carbon offset projects. These are Joint Implementation and Clean Development Mechanism projects created and guaranteed by the UN.

One academic source estimates that the European market has avoided a release of 1.2 Gt in 17 years. While this is a significant decrease, the hardest part is yet to come, as the annual volume of allowances will decrease to reach a target of -55% of European emissions in 2030, and net zero in 2050. In addition, the price of allowances has risen sharply. In this context, companies will find it increasingly difficult to reduce their emissions, comply with their allocated allowances and avoid penalties. However, two tools could enable them to steer decarbonization action to adopt a responsible financial strategy: the internal carbon price (ICP) and climate dividends. In the company’s carbon footprint assessment, the ICP is more likely to concern scopes 1 and 2, and climate dividends concern scope 3: these two tools are therefore complementary.

The internal carbon price and its three main forms

The internal price of carbon is a tool within companies, based on voluntary participation. It consists of a company giving economic weight to its carbon footprint and therefore steering its financial strategy by taking this aspect into account. In 2021, 2012 companies worldwide had already adopted it or were in the process of doing so. In France, this represents 300 companies, including half of the CAC 40. Companies subject to the EU ETS are using it for projects not related to activities within the EU ETS, or to anticipate the risk of a rise in the notoriously low EU ETS price. Internal carbon pricing takes three main forms. In a company’s strategy, these three forms correspond to prospecting (guide price), immediate (internal carbon tax) and retrospection (implicit price). Wherever possible, it is wise to adopt all three to have a complete picture. The internal carbon price will enable the company to achieve its decarbonization objectives and to anticipate the evolution of carbon taxes and climate risk. According to Vincent DUCROS (Getlink), it is a tool for social and environmental responsibility and risk management. Its role is to facilitate work to improve the company’s energy efficiency and accelerate access to low-carbon investments. On this last point, the climate dividends proposed by Time for the Planet (TFTP)  come at the right time to take over from the internal price and provide a clear solution to the financing aspect of scope 3 of the carbon balance, while enriching the range of solutions available in scope 4 (avoided or captured emissions) for companies.

The principle of climate dividends

A climate dividend is equivalent to 1 t CO2e (CO2 equivalent) avoided or captured. It was conceptualized by TFTP with the help of ADEME, Carbone 4 (via Net Zero Initiative) and Sweep. According to Emma SCRIBE (TFTP), TFTP’s ambition is to raise €1 billion over the next ten years, which could generate at least 75 million climate dividends, or 75 Mt CO2e avoided or captured. Climate dividends aim to measure the climate impact via the avoided emissions of a capital investment. The climate dividend cannot be subtracted, added to, sold, assigned, or traded. It has no market value. It is an extra-financial indicator of the contribution of companies to decarbonization via their investments. It helps to avoid greenwashing. The aim of the climate dividend is to value investments in innovations that make it possible to replace existing equipment with a more virtuous technology in order to apply either a reduction – for example with Leviathan Dynamics, a water-based air conditioning system – or a sequestration of greenhouse gases – with Carbon Impact, a rock, olivine, is reduced in the form of sand and then poured into the oceans in order to capture CO2 from the oceans and the atmosphere. Buying climate dividends would allow any company to increase its rating in terms of Environmental, Social and Governance policies. Climate dividends can then be used in extra-financial documents or in communications on reduction initiatives. The capacity of a company to generate climate dividends could then be financially accounted for in its valuation (e.g. 100,000 dividends at €10 per unit generated over two years could add €1 million to the company’s valuation).

To meet the Fit for 55 GHG emission reduction targets, which are more or less ambitious depending on whether or not a company is part of the compliance market, the use of decarbonization support tools will be necessary. The complementarity of the internal price of carbon in its three forms and climate dividends will facilitate the transition and reduce the risk of bankruptcy regarding global warming. Indeed, ignoring the environmental aspect in its financial decisions will be increasingly unthinkable for a company from a societal and functional point of view: to comply with the Paris agreements, it will be necessary to invest several tens or even hundreds of trillions of euros worldwide between now and 2050 – on the scale of France, €65 to €95 billion/year. However, the full decarbonization of the world economy will only be effective and achievable thanks to a convergence of carbon prices (ICP, voluntary and compliance markets) towards a price that guarantees the complete abandonment of fossil fuels in parallel with carbon markets operating by zones (USA-Canada, Europe, China-Asia, etc.) with rules for movement between the zones to prevent carbon leakage (this is the purpose of the EU’s Border Carbon Adjustment Mechanism (BCAM) included in the Fit for 55 proposals). The France Stratégie commission chaired by Alain QUINET in 2019 estimated that the titular carbon price for the European bloc should currently be €80 to €90 per ton of CO2 equivalent (i.e. a little less than the current price in the EU ETS, €250 to €300 by 2030 and €800 by 2050.