Our Thoughts

Internal carbon pricing and its role in mitigating transition risks

Against a backdrop of clear climate change, companies and countries across the world are working to reduce emissions - with many establishing net zero targets within the next decade. However, the effort required to achieve such targets is significant.
Shane Caldwell Shane Caldwell
Shane Caldwell Ellen McKinney
10 October 2023 5 mins read

Ireland’s Climate Change Advisory Council (CCAC) recently warned that the country may not meet its ‘2020-2025’ or ‘2025-2030’ carbon budgets unless drastic action is taken to reduce emissions. Moving to a low carbon economy to mitigate climate change to the extent required will give rise to transition risks across various sectors, including the built environment.

For some time now, IPUT has supported the Urban Land Institute’s (ULI) C-Change programme to achieve decarbonisation in the real estate sector. This initiative aims to devise a standardised approach to assessing and disclosing climate transition risk as it applies to property valuations. One issue that has increasingly come into focus is internal carbon pricing with some real estate organisations now voluntarily applying a levy on the volume of CO2 they emit in the course of their activities. ULI is working with the real estate industry to identify the barriers to a wider adoption of carbon pricing and to devise best practice to ensure the industry is ready to adopt this approach.

Governments and corporates globally have long agreed that carbon pricing has a significant role to play in the transition to a decarbonised economy.

Carbon pricing was specifically mentioned in the Paris Agreement as a ‘tool’ to encourage organisations to reduce emissions and several jurisdictions have since implemented their own carbon pricing policies. While energy-intensive industry sectors such as utilities, aviation and maritime transport have been using internal carbon pricing as part of their risk management strategy for several decades, carbon levies are not yet commonplace in the real estate sector. As the ULI C-Change Summit takes place in Copenhagen, it is timely to question why relatively few of the more than 68 countries that have already implemented a carbon tax are applying real estate activities specifically.

Although carbon levies are not applied universally across the property sector, an increasing number of real estate organisations are now exploring and starting to implement internal carbon pricing models and we expect this will increase significantly over the coming years.

Imposing a carbon levy forces organisations to either transform their activities, operate more sustainably and lower emissions; or pay a price for not making changes to their current practices.

IPUT is an early adopter of this approach having last year introduced an internal carbon price of €80 per tonne on embodied carbon emissions generated in our developments. Our ambitious net zero carbon 2030 pathway demands a radical change in our approach to designing, constructing, and operating our assets. Our primary aim in introducing internal carbon pricing is to promote sustainable construction and operational practices within our supply chain and, in turn, reduce carbon emissions. This will help us to achieve the stringent targets we have set ourselves on our journey to net zero. Embodied carbon is the largest emissions category within our direct control, hence we decided to focus on this element.

Key benefits of introducing an internal carbon price include:

  • Making carbon considerations more central to all business operations;
  • Improving understanding and awareness of carbon across the business, with stakeholders and the wider industry;
  • Re-allocating investment towards more low carbon alternatives;
  • Future-proofing the business for inevitable carbon taxes and other potential regulatory changes;
  • Generating funding to support our sustainability initiatives

The funds generated from this internal levy are ringfenced into a ‘Transition Fund’ and reinvested in projects and initiatives that improve the sustainability performance of our assets and help decarbonise our portfolio.

Our transition fund generated €3 million in 2022. Crucially, we do not use this to solely fund our various retrofit projects. Instead, this fund is allocated to initiatives that focus on carbon avoidance, reduction and removal across our business. It is also used to finance research into low-carbon solutions that have potential to improve energy use intensity across our developments. It also funds key training to upskill our own team and our supply chain on developing and operating net zero buildings.

In addition to being a source of finance to support our green ambitions, the internal carbon pricing model is changing behaviour. Putting a monetary cost on carbon in our projects incentivises us to reduce embodied carbon at design and material selection stages. We undertook significant research before setting the rate at €80 per tonne but will review this over the coming years. The rate needs to be meaningful enough to effect change without being prohibitive or punitive.

Counting carbon is now central to our approach to developments at IPUT and has focussed minds across all areas of our business on achieving carbon reductions.

In addition to having an internal carbon pricing model in place, some funds also implement a ‘shadow cost’ system. Unlike the internal carbon pricing model, which affects the bottom line, shadow costs are not realised or taken out of the business. Shadow pricing is instead a hypothetical metric for measuring future risk and pre-empting likely future costs. Companies implement shadow pricing to hedge against any future policy changes regarding carbon pricing and to ensure they are fully prepared for future climate regulations.

Understandably, there will be many in the industry who will ignore carbon pricing until such time as they are forced to adopt it. Some will see it as further bureaucracy and/or unnecessary cost and will have concerns about the impact adopting this stance will have for margins and their competitiveness. It will pose challenges for smaller players. However, on the basis that real estate is a long-term investment, ignoring the costs of carbon emissions is simply not an option.

As the focus on reducing carbon escalates over the coming years, we expect that the benefits of adopting internal carbon pricing and shadow pricing models will become clearer. As this evolves, there will hopefully be greater consensus across the real estate industry on how to implement these models effectively. One thing that is certain is that early adopters of internal carbon pricing and shadow pricing will be rewarded for their forward thinking.