Have you ever paused to think about the consequences of your business decisions?
To what extent do enterprises rely on carriers once their greenhouse gas (GHG) emissions strategies are established?
Focusing on the legislative landscape, in 2023, several regulatory measures, including the California law and other regional or national policies, were enacted to mitigate greenhouse gas (GHG) emissions. In response to these regulations, companies are obligated to comply with emission limits and other environmental standards. Failure to adhere to these limits can result in financial penalties or legal consequences. For this reason, companies are increasingly adopting carbon shadow pricing as a strategic tool to align with these regulatory requirements.
Carbon shadow pricing is crucial for companies to navigate the challenges and opportunities presented by climate change, regulatory developments, and shifting consumer preferences, as it promotes responsible business practices and helps organizations build resilience in the face of a changing global landscape.
The complex task of picking carriers stands at the center of this commitment, and the critical point of this decision-making journey lies in the concept of "Internal Carbon Pricing," a tool that profoundly influences decision-making and operational choices.
This transformative decision-making process demands a holistic, comprehensive, and accurate evaluation that extends beyond mere monetary considerations. With no coherent global carbon price, companies need to set their own price through a shadow or internal taxation mechanism.
Delving into the imperative of adopting a holistic view, our compelling example underscores the significant impact of adopting a comprehensive perspective. But before delving further into the discussion, let's clarify some key points.
Understanding “(Internal) Carbon Pricing"
The fundamental idea behind carbon pricing for Scope 1 and 2 emissions is to ensure emitters pay for their environmental impacts through a measurable cost signal, encouraging businesses to limit their emissions. Without a coherent global carbon price, many enterprises use internal carbon pricing mechanisms to address climate change's impacts, risks, and opportunities.
The two key internal carbon pricing tools are Shadow Pricing and Internal Carbon Tax; each is pivotal in guiding sustainable decision-making.
Shadow Pricing: Shadow pricing is a tool businesses use that enables them to understand, evaluate, and assess future risks. Instead of waiting for government-imposed taxes, companies estimate a carbon price internally, embedded in all their financial appraisal decision processes. Global companies might consider different prices for different regions or use expected future carbon prices to guide current decisions. This estimated price, known as the shadow price, acts as a signal to help companies make sustainable choices for the long term by factoring in an assumed cost for emissions.
According to Gartner research, the indicative shadow price in 2022 for Scope 3 emissions stands at 37 USD per ton in 2022. Other prices that can be used are the WEF pricing of emissions, which stands at 61-122 USD, and the EU ETS, which ranges between 81-115 USD.
Internal Carbon Tax: Internal carbon tax serves as a mechanism by which companies decide to charge their different units for the carbon emissions they produce. The internal carbon tax also encourages business units to gradually shift towards activities that have lower carbon emissions. More specifically, international guidelines, like the UN Global Compact, recommend that companies set an internal price for carbon emissions, suggesting a rate of $100 per metric ton.
VesselBot's example
In the realm of freight transportation, companies often make decisions based solely on the upfront cost per unit, such as per TEU, when selecting carriers. This approach, however, fails to consider the broader implications of carbon emissions generated throughout the transportation process. Our research on carbon shadow pricing illuminates a critical oversight in this traditional decision-making process.
At VesselBot, we shed light on the often-overlooked intersection of freight costs and environmental impact in global trade. Our analysis focused on two critical trade lanes:
1. From Rotterdam to Los Angeles.
2. From Shanghai to Rotterdam.
In our study, we evaluated several carriers operating along each trade lane, considering both their upfront freight costs and the environmental consequences of their emissions. The results, as illustrated in the tables below, reveal a fascinating narrative of how seemingly cheaper options can incur hidden costs when taking into account the broader context of carbon emissions.
In this case, CR4 emerged as the most cost-effective option, seemingly offering the lowest freight rates among the carriers analyzed.
Interestingly, after accounting for shadow pricing, CR1 emerges as the most economically favorable choice, surpassing CR4. This shift underscores the hidden costs associated with emissions and highlights the importance of considering environmental factors in freight transportation decisions.
Similarly, in the trade lane from Shanghai to Rotterdam, CR4 was perceived as the most cost-effective option.
In this revised ranking, CR4 maintains its position as the most economical choice, even after considering emissions. However, CR2 surpasses CR1 in terms of cost-effectiveness when shadow pricing is taken into account.
Today's choices, tomorrow's returns
The above examples clearly depict how factoring in the cost of carbon emissions in financial planning provides a more comprehensive and holistic view of the shadow operational cost. The key factor of carbon shadow pricing is that it enables better risk management, budgeting, and informed decision-making.
Especially for companies with complex supply chains that need to assess the environmental impact of their entire value chain, carbon shadow pricing is critical when evaluating suppliers, identifying potential risks, and collaborating with partners.
As customers and investors are increasingly considering ESG factors, companies that account for carbon emissions and demonstrate a commitment to sustainability may attract a wider pool of investors and benefit from stronger relationships with existing stakeholders. Companies that proactively address their carbon footprint by incorporating carbon shadow pricing may gain a competitive advantage, attracting environmentally conscious customers and investors.
Carbon shadow pricing is crucial for companies to navigate the challenges and opportunities presented by climate change, regulatory developments, and shifting consumer preferences, as it promotes responsible business practices and helps organizations build resilience in the face of a changing global landscape.
Finally, these findings underscore the imperative of holistic decision-making in freight logistics. By providing visibility into the hidden costs associated with emissions, we empower businesses to make informed and sustainable choices aligned with their values and long-term objectives.
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