Implicit cost of carbon emissions: Design the internal carbon price in the decision-making process

In the debate on carbon reduction, carbon pricing has become the norm to motivate the actors to work on the issue through economic incentives. Given that more and more relevant policies such as emission allowances or taxes are being released recently and might have a direct impact on operating costs, it is far more essential for companies to identify the implicit cost of emissions.

Internal Carbon Pricing is one of the strategies increasingly used by companies to support the decision-making process to deal with the risk associated with the additional cost of emissions, which helps drive environmental efficiency, change internal behavior, and navigate greenhouse gas regulations across departments. However, there remains a lack of an appropriate approach to accurately express the implicit cost of emissions, which makes it difficult for companies to devise the internal pricing level. In addition, the collection of the pricing policy largely depends on the level of energy consumption of each department, which casts doubt on the representativeness of environmental efficiency.

This study proposes an analysis of implicit carbon pricing based on the concept of the marginal cost of emissions, which includes the additional investment needed in emissions-reducing or -removing projects and the incremental cost that come from relevant regulations that might increase with the emission level. The work calculates the marginal cost of emissions by using linear programming; economic performance serves as an objective function and the mitigation target of the company as well as the available resources constitute the constraints. Moreover, to estimate the environmental efficiency, the study introduces Data Envelopment Analysis (DEA) to measure the relative efficiency between departments and derive an efficiency score as a marginal cost adjustment factor in designing the internal pricing level.

By the calculation of the marginal cost of emissions, which is still under discussion at present, this study develops a strategy to assist companies in accurately establishing internal pricing levels, thus ensuring the effectiveness of the internal carbon pricing policy that is in line with the company's mitigation target.