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The Business Case for Carbon Pricing Carbon pricing is a powerful tool to prepare for the new, low-carbon economy. It lets companies quickly see – on their books – how different their business will look once emissions carry a cost. Beyond helping companies prepare for future regulation, the mere signal of a can spur companies to become more efficient. Internal carbon prices give managers a bottom-line incentive to move away from fossil fuels, to direct resources to clean energy projects and to avoid investments that could become stranded with tighter regulation of fossil fuels. Already, more than 1,000 companies are using internal carbon pricing or preparing to do so by 2017, according to disclosures to CDP. Companies that lead on the environmental, social and governance factors material to their industries outperform their peers in long-term profits and returns, according to a wave of studies from CDP, Harvard Business School and research firms.i Investors are paying attention to such companies and channeling increasing investments toward them.ii 1. Benefits of Carbon Pricing: Navigating Regulation: Companies that impose an internal price on carbon are better prepared for emissions caps and carbon taxes. Already, 40 nations and 20 cities and regions have such systems, with new ones coming online across China, South Africa and the province of Ontario. At the Paris Climate Summit, 90 nations committed to using market mechanisms to bring down carbon emissions. By 2019, countries representing 89% of global GDP will have some form of carbon taxes or systems.iii Sourcing Requirements: Companies that supply, sell or source internationally will increasingly find their carbon being priced. Major companies with more than $2 trillion in annual purchasing power including Walmart, Microsoft, Royal Phillips, and L’Oreal are already asking their suppliers to report their emissions to CDP, focusing on the hotspots in their supply chain. Leading organizations including HPE and Lockheed Martin are redesigning products for , as 95% of the emissions associated with products come from their use and sourcing. Carbon Efficiency: Carbon pricing spurs innovation so companies can set trends rather than adapt to them. Carbon pricing steers managers away from carbon waste and offers them a new lens to compare the operations of disparate business units. In addition, it helps companies forecast capital investments – channeling them to clean and carbon-efficient technologies. The companies embracing emissions pricing include recognized leaders in their sectors including Google, Microsoft, Phillips, and Unilever. 2. How do companies use internal carbon pricing? Global companies may use several types of carbon pricing depending on geography, business units, and goals. Shadow Prices let companies test planned projects under a range of potential carbon prices and policies. Just as they forecast fuel prices, many energy companies model carbon prices to lower the risk of stranded assets. The U.S. industrial conglomerate Owens Corning places an economic value of $10 -$60/metric ton on carbon emissions “to help frame the challenges and opportunities in monetary terms, more broadly understood than simply tons of emissions….” Statoil ASA of Norway applies an internal price of at least $50/metric ton “to all project investment decisions and which we use for portfolio management and strategic considerations.” Internal Prices, a fixed value assigned to each metric ton of emissions, reveal hidden carbon risks. When emissions bear a cost in profit-and-loss statements, it helps to highlight inefficiencies and reward managers who use innovative design, processes, and sourcing to cut energy use and carbon pollution.

Within Goldman Sachs, “all relevant business units factor an Internal Price on Carbon into energy efficiency, and other emission reduction activities through the use of a Return on Investment model… [as part of a] carbon reduction framework which prioritizes internal reduction measures across both our data centers and offices….”

Internal Taxes go a step further to actually charge business units for their emissions, collecting fees that can support investment in clean technologies, to help the entire company transition to low-carbon.

In 2012, Microsoft began charging its business groups for emissions from offices, labs, datacenters, and air travel. A central fund invests those fees, which last year were $4.40 per metric ton, in energy efficiency, green power, and carbon offsets to ultimately enable Microsoft to become net carbon neutral.

Adobe does, indeed, charge each business unit for costs associated with resource consumption. The goal being to implement resource efficiency projects to reduce costs, mitigate business risk, and implement new technologies…

Companies that set a goal of cutting emissions or going carbon-neutral can calculate their effective or implicit by dividing cost of achieving these reductions by the number of tons saved. This is how Unilever calculates an implicit price of doubling its use of renewable energy to 40% by 2020.

3. Investors are Paying Attention Many active investors have long focused on a company’s climate impact, believing that good environmental performance is a proxy for good governance. Passive investors, who represent 40% of all managed assets, can now act on climate as well. Quantitative finance has figured out how to lower the carbon emissions of index- based portfolios, while matching the historic risks and returns of the benchmark. Global asset managers, including Axa, Amundi, BlackRock, State Street Global Advisors, and Goldman Sachs now offer such funds, which invest more in carbon-efficient companies and less in carbon-intensive ones. Additionally, new regulations in France and elsewhere in Europe are directing pension funds toward climate and other ESG themes. Amundi for example, already incorporates a carbon price within valuation models for European utilities and considers CO2 regulation within valuation models for automotive companies. Funds with environmental, social or governance (ESG) mandates represented 30% of the world’s invested capital in early 2014, according to the Global Sustainable Investment Alliance. And funds based on climate and other sustainability themes outperform traditional funds in most cases, according to research from Morgan Stanley.iv These developments are making it easier for investors to channel their assets to vanguard companies, including those using carbon pricing as a tool to manage and gauge risk. Contact: [email protected]

i Khan, Mozaffar and Serafeim, George and Yoon, Aaron, Corporate Sustainability: First Evidence on Materiality (March 9, 2015). The Accounting Review, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2575912 orhttp://dx.doi.org/10.2139/ssrn.2575912; Eccles, Robert G. and Ioannou, Ioannis and Serafeim, George, The Impact of Corporate Sustainability on Organizational Processes and Performance (November 23, 2011). Available at SSRN: http://ssrn.com/abstract=1964011 or http://dx.doi.org/10.2139/ssrn.1964011; ii Eccles, R. G., Serafeim, G. and Krzus, M. P. (2011), Market Interest in Nonfinancial Information. Journal of Applied Corporate Finance, 23: 113–127. doi: 10.1111/j.1745-6622.2011.00357; Cheng, Beiting and Ioannou, Ioannis and Serafeim, George, Corporate Social Responsibility and Access to Finance (May 19, 2011). Strategic Management Journal, 35 (1): 1-23.. Available at SSRN: http://ssrn.com/abstract=1847085 or http://dx.doi.org/10.2139/ssrn.1847085 iiiWe Mean Business, calculated from State and Trends Report 2015 and national commitments made at COP-21. iv Morgan Stanley’s “Sustainable Reality” report found that sustainable equity mutual funds met or exceeded median returns of traditional equity funds during 64% of the time periods examined. From 2008-2014, sustainable equity funds met or exceeded median returns for five out of the six different equity classes examined (e.g. , large-cap growth)9. http://www.morganstanley.com/ideas/sustainable-investing-performance-potential/