Cost pass-through is a pricing strategy where a business passes on the costs of producing or acquiring a product or service to the customer by increasing the price. This approach is often used by businesses that face volatile input costs, such as raw materials or labour, which can fluctuate based on market conditions or other factors.
The cost pass-through methodology involves analysing the costs associated with producing or acquiring a product or service, and determining how much of those costs can be passed on to the customer. This analysis typically involves considering factors such as the level of competition in the market, the elasticity of demand for the product or service, and the overall price sensitivity of customers. Once the analysis is complete, the business can adjust its pricing strategy to reflect the costs it incurs. For example, if a company sees a significant increase in the cost of raw materials, it may choose to raise its prices to maintain its profit margins. Alternatively, if the company wants to stay competitive in the market, it may choose to absorb some of the increased costs and only pass on a portion to customers.
CPT allows companies to transfer some of the increasing carbon costs to their clients, providing a financial cushion. For the short-term stress test, the balance sheet of the counterparty can be considered fixed, as the increase in carbon price will mainly manifest itself through the income statement. To develop a robust CPT methodology, typically there are three questions that organizations must address. –
- To what extent will costs increase due to the carbon tax?
- To what extent will the company be able to transfer these costs to the consumer?
- How will a new equilibrium be obtained based on micro-economic interactions?
The extent to which costs will increase due to a carbon tax depends on various factors, such as the initial tax rate, the sectors and industries affected, the level of carbon emissions reduction required, and the responsiveness of businesses and consumers to the tax.
In general, a carbon tax is designed to increase the cost of goods and services that are produced with high levels of greenhouse gas emissions, such as fossil fuels. However, the actual impact of a carbon tax on costs will depend on the specific design of the tax policy, including any provisions for exemptions, rebates, or offsets. Overall, the impact of a carbon tax on costs is a complex issue that depends on many factors and will vary from industry to industry and from country to country. However, a well-designed carbon tax can provide a powerful incentive for businesses and consumers to reduce their greenhouse gas emissions and transition to cleaner and more sustainable energy sources over time. The following is an illustration of a simplified approach to calculate carbon cost.