Agreements and Memberships Shadow Carbon Pricing
A key feature of the Enhanced Diligence Process is the use of “shadow carbon pricing”. Concern over climate change has led to policies that put a price on carbon emissions using either a market-based emissions trading system (“cap and trade”) or a carbon tax, both of which can affect the operating cost of a power plant. A well-known example of carbon pricing is the European Union cap-and-trade system. Carbon taxes have also been introduced in various federal, state and local jurisdictions. Policymakers in many countries, including emerging markets, are considering the introduction of these policies. In the US, cap-and-trade systems exist or are in development at the state level, notably California, and federal cap-and-trade bills have been proposed in the US Congress.
The evolving policy environment creates uncertainty around the price for carbon, especially over the long lifetime of a power plant. Shadow carbon pricing addresses this uncertainty by introducing a hypothetical price, or shadow price, as an input to the financial analysis of the plant. The shadow price can be introduced to the base case, or the analysis that represents expected conditions, as well as sensitivity cases, which analyze financial performance under various, less probable scenarios.
Through its experience with the Carbon Principles, Credit Suisse has seen shadow carbon pricing emerge as standard practice for power plant financings in the US. When the Principles were launched in 2008, shadow carbon pricing was still relatively novel. Now, however, the assumption of a price on carbon is routinely built into both the base case and the sensitivity cases for coal-fired power plants. Even though US federal action on climate policy has slowed in recent years, the use of shadow carbon pricing is still commonplace even in base case analyses.
Shadow carbon pricing may factor into the regulatory process that power generation companies must follow to obtain approval for new generation capacity and the rates they can charge to customers. Public utility commissions vet the assumptions made in an application for new power generation, and this process may involve significant public comment. Importantly, when the power company receives approval for its rates, the approval may include cost recovery that allows any future carbon costs to be passed through to the customer. In this case, the financial risk to the project and the company is mitigated, regardless of the timing and magnitude of the carbon price.