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Perspective - Markets

Burning ambition: The price of tackling climate change

Europe wants to become a zero-emissions economy by 2050. To remain competitive, new green border taxes may be inevitable.

08/07/2019

Simon Webber

Simon Webber

Lead Portfolio Manager

Many European countries, and the European Union (EU) itself, have set themselves ambitious targets to achieve a zero-emissions economy by 2050. To maintain a level playing field when trading with other countries around the world (particularly those with lower environmental regulations), it seems inevitable that the EU will have to impose new green border taxes in order to achieve this target.

The EU has always been at the forefront in the battle to tackle climate change. It pioneered the first major carbon emissions cap and carbon trading scheme and European countries such as Germany, Italy and Spain did most to support the early development of a solar power industry. The EU has also consistently set the most ambitious targets for reducing overall emissions among major industrialised economies.

Some of the necessary technologies, such as clean energy and electric vehicles, are both mature and already cheaper than the traditional fossil fuel energy products. But these only deal with power generation and transportation. Meeting the zero-emission economy goal by 2050 will also require change and disruption in several other industries where the costs of transformation will be higher or technologies still need to be funded and developed.

This includes industries such as agriculture, cement, steel, aluminium, aerospace, and a range of other manufacturing industries where there will be significant costs associated with decarbonisation. It will simply be politically unacceptable to impose those costs on European companies while overseas competitors do not bear the same costs.

Green taxes needed to ensure a level playing field for trade

Given that some aspects of tackling climate change will be expensive, border carbon adjustments (BCAs) will be the only way the EU will be able to ensure a level playing field for trade. This is unless other countries (in particular, China and the US) also implement similarly strict environmental regulations and move away from their dependence on coal and oil.

Without this protection, industrial production will just move to parts of the world with lower environmental regulations. This would not only defeat the object of the exercise, but would also weaken the EU’s economy, essentially penalising it for its bold environmental stance.

The potential new charges would not be targeted at any one country and could be designed to adjust for the carbon intensity of the specific production source for the material. If this data is unavailable, a charge could be levied that adjusts for the average carbon intensity of the power consumed in the industry in the country of origin.

The London-based think tank Climate Strategies said that BCAs have conceptual appeal and are politically popular in certain countries. “They promise to level the playing field in competitive markets, prevent leakage of carbon emissions, and incentivize trade partners to strengthen their climate efforts,” it said in a research paper published in December 2017.

Green politicians face difficult balancing act

Green parties across Europe recorded a strong performance in May’s European parliamentary elections. Concerns about the environment and global warming rose up the political agenda following widespread protests in major cities around the world by the activist group Extinction Rebellion earlier in the year. Newly elected Green politicians seeking to implement robust environmental policies will need to ensure they protect Europe’s economic prosperity and competitiveness at the same time.

Meeting the zero-emission goal will likely require the EU to shift all its steel and aluminium manufacturing to clean production processes. In the case of aluminium, manufacturing the metal from a coal-powered smelter produces 10 tonnes more greenhouse gas emissions than one that uses hydro power. This equates to €250 at today’s EU carbon price, which is more than 10% of the metal’s price.

Although Europe is on track to make this transition, most other countries in the world continue to use coal in their aluminium production plants. At €100 per tonne, which is where the carbon price will likely end up to achieve the targets set under the Paris agreement, the difference in costs (or the currently unpaid environmental cost of production) is worth more than half the current price of the commodity.

Products made in coal-fired plants will face restrictions

If Europe wants to have a zero-emission economy it cannot import aluminium products that are made in coal-powered plants. Such imports will need to be de-incentivised in a similar way that coal based production is de-incentivised under European regulations, which is currently through the carbon price (the ETS). A BCA would simply apply the EU price of carbon to the amount of embedded carbon in products being imported into the region. The idea appears to have support from industry players.

“If the world is to successfully address climate change, the answer is not for one region to outsource its carbon footprint to another and claim victory”, Lakshmi Mittal, chief executive officer of ArcelorMittal, the world’s largest steelmaker, wrote in an article in the Financial Times in May 2019. “Rather any country or region that wants to play a role in reducing global emissions needs policies in place that build a low-carbon industry.”

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