Shadow carbon pricing
This page is part of the E3G Public Bank Climate Tracker Matrix, our tool to help you assess the Paris alignment of public banks, MDBs and DFIs.
This metric focuses on the application and level of shadow or internal carbon pricing used by each bank. The application focused on the coverage of shadow carbon prices across a bank’s portfolio of projects and the level of importance given to the shadow carbon price in decision-making. With regards to the adequacy of levels we note that the High-Level Commission on Carbon Prices (HLCCP), a World Bank initiative, recommends carbon prices of $40-$80 per tonne of CO2 by 2020 and $50-100 per tonne by 2030 to keep global warming below 2°C.
We are however aware that carbon pricing is not a perfect tool for delivering mitigation and therefore we also consider the wider drawbacks and potential perverse incentives of carbon pricing in this section.
The sources used for the carbon price used within banks were drawn from publicly available information, usually in the form of guidance notes. It is worth noting that prices were in 2016 prices, adjusted for inflation and EBRD and EIB prices have been converted from EUR to USD using OECD conversion rates. Also, the EIB and EBRD use ‘tonnes of carbon equivalent’, while the others refer to ‘tonnes of carbon’; it is not clear whether ‘carbon’ is being used as a shorthand in these documents.
To be ‘Paris-Aligned’ the carbon pricing level was in line with the High-Level Commission on Carbon Prices (HLCCP) recommendations. ‘In line’ is defined as meaning at least in the mid or upper-range of these recommendations. In addition, we monitor the sectors in which shadow carbon pricing is applied .
To be ‘Transformational’ this shadow carbon price is set at a higher level taking into account tipping points and ecosystem damages, and there is evidence that this is being regularly reviewed to take into account new science.
This is an important part of operationalising the commitment the MDBs made at COP24 to “be compatible with the overall climate change mitigation objectives of the Paris Agreement”.
Evolution of this indicator
Further research could look into whether carbon pricing is applied to Scope 3 greenhouse gas emissions of projects, where relevant. In addition, subsequent research could explore case study examples for how the shadow carbon pricing is applied in practice.
Shadow carbon pricing is a tool in internal financial and economic appraisal to encourage low-carbon investment or deprioritise high-emission projects. If shadow carbon prices are applied at the correct level and in the correct way, theoretically, only projects compatible with a low-carbon transition would gain funding.
Whilst an important tool in assessing a prospective projects alignment with the Paris Agreement, shadow carbon pricing is not a silver bullet for triggering a change in investment portfolios. Instead, it is a supplementary tool that can be used to inform decision making. To be effective, its use must go beyond the isolated application of a price per ton of CO2e and should be applied in the right way in conjunction with effective GHG accounting. Particular care should be taken as to how carbon pricing is applied to projects that due to various baselines show a relative saving in GHG emissions.
In some sectors such as buildings and transport, several other barriers are in place. A notable example is the ability to formulate alternative low carbon investments that can be subject to a carbon price. The World Bank found high carbon prices were not sufficient to incentivize low-carbon transport, for example. For buildings, demand side focused energy efficiency investments already have an economic case, but incentives may not exist for the building owner if they are not responsible for paying energy bills (the landlord-tenant split incentive). The effectiveness of shadow carbon pricing is also dependent on how the appraisal process is set up and how this informs decision making, for example, whether it is used as a hurdle to investment and again what baseline is used to calculate relative GHG emissions.
Related to this metric is the role of public banks in supporting countries with long term planning and policy support. If fossil fuel subsidies exist within a country, this can act as a counter to a carbon price that is applied to internal decision making within a public bank. Therefore, if supporting countries ratchet down these subsidies it can support the usefulness of a shadow carbon price.
Ascertaining the correct value of a (shadow) carbon price to achieve the Paris Agreement is subject to debate. The High-Level Commission on Carbon Prices (HLCCP), a World Bank initiative, has recommended carbon prices of at least $40-$80 per ton of CO2 by 2020 and $50-100 per ton by 2030 to keep global warming below 2°C. The phrasing “at least” suggests the public banks should be using the highest end of this range. Furthermore, the Paris Agreement strives to limit warming to below 1.5°C, the IPCC Special Report on Global Warming of 1.5°C cites a range for the (non-discounted) social cost of carbon of between $135 to 5500 / tCO2-eq in 2030, and $245 to 13000 / tCO2-eq in 2050, ranges which, even when discounted, are substantially higher than the HLCCP ranges for limiting warming to below 2°C. This must factor in public bank’s decisions when choosing a shadow carbon price. For comparison across MDBs in this Matrix, the HLCCP values will be used as a reference point.
Recommendations for the MDBs include:
- Applying a shadow carbon price across all investments (above an appropriate significance threshold), not just those that reduce emissions.
- Clarifying how shadow carbon pricing is applied to decision making. This includes disclosing which discount rates are used for country categories, alongside the rationale and evidence for such rates, and how the carbon price is used with projects that show GHG emissions savings.
- Using carbon price scenarios that are at the highest end of the range of the High-Level Commission on Carbon Prices as a screen for alignment with limiting warming below 2°C. Public banks should also apply a second – higher – carbon price scenario to assess alignment with limiting warming to below 1.5°C.
- Ensuring that indirect emissions, even if not directly controlled by the project (Scope 3) are included. Their inclusion can substantially change the assessment of the environmental impact and thus are material to investment decisions.
The role of carbon pricing in addressing natural fossil gas projects is particularly important. To ensure an effective approach public banks need to:
- Estimate full life cycle greenhouse gas emissions along the gas supply chain and include fugitive emissions as Scope 1 emissions, as in AFD and GHG Protocol’s best practice.
- Use an emissions factor for gas investments in line with latest science and update the global warming potential of methane to a value of 84 based on a 20-year timeframe. The Sustainable Gas Institute recommends to use a range of 419–636 g CO2 eq./ kWh, with a central estimate of 496 g CO2 eq./ kWh. The analysis should be tested against the upper bound as well.
- Use a time horizon commensurate to the asset lifetime. Gas infrastructure typically has a lifetime of 30-80 years.
- Compare a range of options in the economic assessment – including energy efficiency, demand side response or grid interconnection – instead of just a business-as-usual option.
- Consider stranded asset and lock-in risk assessment in view of broader decarbonisation policies/climate targets like the expected 5-yearly ratcheting up of decarbonisation targets.