Nov 21, 2017

Pricing Carbon in Brazil

Carbon pricing – a key tool to combat climate change – is gaining momentum all around the world, including in emerging markets such as Brazil. Since 2013, there has been rapid growth in Brazilian corporate adoption and support for carbon pricing as a mechanism to prepare for a climate-constrained future. Three companies from Brazil’s business community sat down to share their experience with carbon pricing as part of the Internal Carbon Pricing: Practical Experiences from the Private Sector webinar series.

Itaú Unibanco, CPFL, and Vale—respectively Brazil’s largest private bank, largest private electric utilities, and a global mining company—are among 39 companies participating in a simulated emissions trading system to explore approaches to a Brazilian carbon market. Through the simulation, businesses learn how to operate in a carbon trading scheme and work closely with academia and the government to consider the most appropriate carbon pricing instruments. The webinar featured Luiz Osorio, Vice President at CPFL; Fabio Luiz Guido, Sustainable Business Specialist at Itaú Unibanco; and Vivian Mac Knight, Climate Change Advisor at Vale. Hector Gomez Ang, Brazil Country Manager at the International Finance Corporation moderated the discussion.

Business Drivers for Sustainability

Itaú Unibanco, CPFL, and Vale began by sharing their motivations for adopting sustainability and carbon pricing.

“As a global company in an energy-intensive sector, Vale faces international pressure to integrate sustainability in our core processes,” Mac Knight explained. "We have also experienced carbon pricing realities, such as in the UK, Australia, and, most recently, in Ontario, Canada. In fact, we were able to apply our learning from the Brazil simulation to the emissions trading system in Canada.”

For CPFL, carbon pricing helps the company prepare for the future and shape its businesses accordingly. “We already consider carbon pricing in our business plan in anticipation of an eventual regulated carbon market in Brazil,” Osorio said. “The use of carbon pricing in business strategy helps us prioritize investments in disruptive technologies such as electric mobility and storage.”

Itaú Unibanco recognizes its role as a financial market agent in the transition to a low-carbon economy. “We need to measure the carbon emissions of our clients or the projects that we are involved in through investing or crediting, in order to influence companies and sectors to become lower-carbon,” said Luiz Guido.

Use of Internal Carbon Pricing

Each company uses carbon pricing as a tool for both risk management and innovation.

Vale is piloting a shadow carbon price – a hypothetical surcharge to market prices – for capital projects to influence investment decisions. It is also constructing a more complete model to understand the total cost of carbon pricing for a mining company. “Through our risk analysis, we realize that scope 1 emissions, i.e., those from sources that are directly owned or controlled by us, are not the main issue. Scope 2 emissions from purchased electricity are also not significant due to the relatively clean grid of Brazil, where we have major operations. Scope 1 and 2 are therefore small compared to scope 3, or the rest of emissions in our value chain,” said Mac Knight. “So we are analyzing not only the direct cost of carbon pricing but also the indirect cost, and any impact this may have on our supply chain contracts.” For example, if a supplier or a client experiences carbon pricing from their local government, this will have implications for Vale.

CPFL uses carbon pricing to drive strategic investments in areas that will have a competitive advantage in a low-carbon economy, and Itaú Unibanco utilizes carbon pricing differently in each of its three units: credits, investments, and operations.

In assessing credit risk, Itaú Unibanco takes a sectoral and company-level view. The bank evaluates the carbon intensity of different sectors to understand their relative exposure to carbon regulation risks and uses the results to develop strategies to move to a low-carbon portfolio. Within each sector, Itaú Unibanco compares companies to see which are more effective in climate mitigation. It also looks for ways to introduce carbon as a variable in company ratings.

For investments, Itaú Unibanco uses carbon price to project a fair price of the asset when considering carbon emissions. And for operations, the Bank incorporates carbon pricing into traditional financial metrics such as NPV and payback period to decide whether to invest in a new project.

ETS Simulation

All three companies said they have gained valuable experience from the Emissions Trading System (ETS) simulation. While no real money was exchanged, the simulation increased awareness of carbon pricing and its benefits within each company. Specifically, the translation of carbon risks into costs help business units internalize their climate impacts. “The incorporation of a carbon price into business processes and strategies has contributed to a new mindset of decision-making and generated new business opportunities,” said Osorio of CPFL.

For Itaú Unibanco, “the simulation has given us a deeper understanding of how climate change impacts the finance, investment, and insurance industries,” said Luiz Guido. “With this understanding, we have reviewed our position on climate change and organized workshops for our managers, in order to show them that the price of a company or asset may not only be composed of financial metrics but also carbon impacts.”

“The simulation itself is not resulting in emissions reductions, but the increased awareness and understanding of how to introduce carbon pricing within companies will lead to reductions,” Mac Knight emphasized.

Through the simulation, businesses are also working closely with the government to analyze different options for a nationwide emissions trading system. This analysis will be submitted for approval in 2019 and is expected to take effect in 2020. “The Brazilian government recognizes sustainability as a source of competitive advantage,” said Osorio. “Brazil has a clean electricity generation mix, with half of the country’s domestic energy supply already coming from renewables.”

Looking forward

Itaú Unibanco, CPFL, and Vale are working to further embed carbon pricing into their businesses. For example, Vale is trying to incorporate carbon pricing into operations, including day-to-day budget cycles and strategies. “We are developing marginal abatement costs to help business units understand whether it is more cost-effective to reduce emissions internally, buy credits, or pay fees to be in compliance with carbon regulations,” said Mac Knight. “Most of our emissions come from scope 3, so we are also working with clients to research how our products can be better used to reduce emissions.”

“The private sector has a fundamental role in addressing the issue of climate change, and through dialogues in this simulation, we are pushing the government to be more ambitious in implementing Brazil’s commitments under the Paris agreement,” Osorio concluded.

Watch the full webinar here: