How do industrial consumers manage carbon pricing?

How do industrial consumers manage carbon pricing?

As the energy market has evolved, the market on which energy has traded has evolved in tandem. Carbon pricing touches and impacts every operation that takes place within industrial value chains, with each output linked back to a carbon factor.

Certain industries, such as the power, cement, steel, chemicals, refining, and paper industries, are consumers of large amounts of energy. Energy-intensive industrial users have had to employ specific tactics to measure, hedge, pass through, or mitigate carbon costs, all while meeting reporting obligations, net-zero goals, and avoiding the fines that non-compliance entails. There are currently several schemes that help these heavy users utilise carbon pricing, including the EU ETS, the world’s first emissions trading scheme; the British version, UK ETS; and ETS 2, which aims to reduce carbon emissions specifically from the building and transport industries.

How do carbon costs hit industrial consumers?

To help track and report the amount of emissions a heavy polluter produces, emissions must be declared. These fall into a few distinct categories. Direct emissions, or Scope 1 emissions, are greenhouse gas emissions that a business has direct control over, such as combustion processes in fuel vehicles or process emissions. These are often a legal requirement to be reported. Scope 2 emissions are indirect energy emissions, such as heating and cooling, which can be attributed to the energy company that generated them. Scope 3 emissions refer to indirect emissions not directly created by the company itself. Upstream and downstream exposure may occur through business travel, materials, logistics, or customer interactions.

Policy mechanisms that change competitiveness

Some elements of carbon trading schemes, such as the UK Emissions Trading Scheme (ETS), are included to avoid carbon leakage. Free allocation, benchmarking, and leakage protections aim to prevent companies from relocating operations to regions with less stringent sustainability requirements by mitigating the financial impact of carbon pricing through free carbon allowances. Failure to report carbon emissions can result in significant financial penalties. The Carbon Border Adjustment Mechanism (CBAM) is a requirement in the EU that takes effect from 2026, with fines imposed for non-compliance.

Measuring and forecasting exposure

Many of these mandatory reporting requirements require detailed data capture, analysis of activity data, as well as emissions factors and information gathered from detailed metering. Building an internal carbon price can be useful for measuring outside of mandatory reporting as well. You can build an internal carbon price by measuring Scope 1, 2 and 3 emissions and then setting out a plan to reduce emissions, applying a monetary value to each tonne of carbon reduced, for example. It can aid in planning for procurement or information gathering for CapEx or OpEx, which deals with factors such as updating physical infrastructure or utilities. Companies can also consider elements such as stress testing, which examines how specific events might impact carbon emissions, or scenario analysis, which provides a broader view of general operations. A marginal abatement cost curve (MACC) takes this concept one step further - it grades the economic factors of various carbon emissions efforts per unit that is reduced.

Financial risk management and hedging tools

Various tools are available for heavy polluters to keep compliant and reduce carbon emissions at the same time. Buying allowances, like, for example, European Union Allowances (EUAs), require participation in a cap-and-trade market, through which allowances are bought via auctions, trading platforms or utility brokers or on the secondary market through brokers or trading platforms. Hedging options allow participants to reduce their risk to carbon pricing, such as collars, which make a business more robust against currency exchange risks by avoiding fluctuations within a certain timeframe, or forwards contracts, which lock in carbon pricing over a longer projected period, making forward budgeting much simpler for heavy energy users. With such complex activity around pricing and trading, it’s key that governance is prioritised, particularly in instances of heavy industrial use, where a lot of energy is being consumed. Setting up clear guidance and compliance around how limits and collateral are approached, as well as counterparty risk, is crucial, with a focus on the reporting that surrounds all of these mechanisms.

Operational decarbonisation levers

There are options to reduce carbon emissions levels at the source, if a heavy energy user chooses. Implementing energy-saving actions, such as smart lighting or incorporating energy efficiency measures across operations, can help reduce the carbon emissions created initially, thereby reducing the need for offsetting. Switching to green energy solutions that are suitable for the heavy industrial sector is also a smart move. For some operations, switching fuel sources to natural gas or biomass is a possibility, as is exploiting the electrification of heat and investing in green hydrogen pilots. On-site renewables can circumvent the national grid, potentially creating decentralised sources of energy for businesses, all with storage built in to balance volatile sources of renewable energy in industries in which it's important to always keep the lights on. Options such as heat recovery can generate alternative sources of energy, supplementing fossil fuels, while digital controls can make operations and energy use more efficient. If green energy sources aren’t appropriate, Carbon Capture, Utilisation, and Storage is always an option to remove the generated emissions from the atmosphere after they’re generated.

Power procurement to cut Scope 2 costs

Challenging the way that heavy industries procure energy is another way to reduce costs and cut carbon emissions. Entering corporate PPAs, which are long-term contracts between power producers and power consumers, can make energy, potentially renewable energy, more affordable for heavy industries. Businesses can also decide to enter physical agreements where the procuring business, or virtual agreements, consume energy. Taking advantage of green tariffs can also be a win for Items such as renewable certificates, which can help quantify the source of energy consumed, aiding in the measurement of carbon footprints and their reporting to support compliance and avoid fines.

Common pitfalls to avoid

Numerous mechanisms can help heavy industries participate in carbon pricing, but they should also be aware of the challenges associated with this approach. Be wary of entering into short PPA contracts that don’t align with the asset life of the project, as this can result in the heavy energy user not realising the expected cost savings over the set PPA period. Ignoring network and policy changes can also result in heavy consequences; for example, ignoring the EU's Carbon Border Adjustment Mechanism phases could lead to miscalculated carbon footprints and increased carbon leakage.