Pricing carbon across borders

Pricing carbon across borders

The drive for net zero is increasing the role of governments in their economy through the implementation of new regulations, subsidies and taxes. For now, subsidies are centre stage. The Biden administration’s Inflation Reduction Act (IRA) fired the starting gun with the announcement of a mammoth $369bn in green subsidies. The EU has pledged $270bn in green subsidies as part of its ‘Green Deal’ and, in response to the IRA, plans to ease its state aids policy to boost funding for green projects. The UK Labour Party’s ‘Green Prosperity Plan’ looks like a British version of Bidenomics with major new funding for energy infrastructure and renewables.

• The cost of subsidies is largely hidden from the public in government borrowing or general taxation. Taxing energy at a household level is a different proposition. Energy costs are hugely politically sensitive, as demonstrated by the ‘gilets jaunes’ protest movement in France and the energy crisis in Europe last year.

• The most widespread climate-related carbon tax is levied on corporates, not households, and its costs are therefore largely hidden from consumers. Carbon pricing charges businesses for emissions. The EU has led the charge on carbon pricing and a growing number of other countries have followed. Many countries don’t levy carbon taxes and, even those that do, exempt many types of emissions. Just 30% of global emissions are covered by a carbon price which, in most cases, is far too low to meet net zero targets. The IMF estimates that to limit climate change to even 2°C (above the 1.5°C Paris target) the average global price of carbon needs to rise from $6 per ton of CO2 to $75 by 2030 with coverage expanding to cover every sector and country.

• Unless all countries have a carbon tax those that do put themselves at a potential disadvantage relative to those that don’t. Domestically produced goods and services lose out to imports that do not face the levy, creating an incentive for producers to relocate to lower tax jurisdictions. Without global coordination carbon taxes could create a situation in which efforts to decarbonise are thwarted by the relocation of polluting industries to such countries.  

• To counter carbon leakage the EU is implementing a Carbon Border Adjustment Mechanism (CBAM) that will levy a carbon price on imports into the EU. The details are complex, but make no mistake, this is an important measure, one that is getting attention from policymakers around the world. Europe’s CBAM will be phased in from this October, initially affecting carbon-intensive sectors at greatest risk of carbon leakage - cement, iron and steel, aluminium, fertilisers, electricity and hydrogen. The scope will expand reaching full planned coverage, which will account for half of all sectors covered by the EU’s carbon tax, in October 2026.

• The CBAM represents a logical way of reducing carbon emissions, albeit one that creates risks, as well as opportunities, for European producers. Although the CBAM aims to level the playing field between domestic production and imports, some EU producers will see their costs rise immediately. These companies are heavy emitters and are currently exempt from the EU’s domestic carbon pricing scheme to keep them competitive against imports. With the carbon content of imports now being taxed, the EU plans, quite reasonably, to levy the carbon tax on these domestic producers, pushing up their costs. While in the home market, domestic production and imports will face the same charge, the CBAM will affect the competitiveness of some EU exports which, directly or indirectly, are subject to the levy. 

• There will be second-round effects too. Input costs for many industries will rise, including autos, home appliances, and construction, as industries and importers affected by the CBAM pass on higher costs. The European Central Bank has said that the CBAM, like the carbon price before it, will raise inflation. We expect to hear a lot about so-called ‘greenflation’ in the next few years as the costs of the energy transition feed into the general price level.

• While the EU regards the CBAM as an environmental measure, other countries may see it as a form of protectionism, leading to retaliatory tariffs and restrictions on trade. The current trade dispute between the EU and US over steel and aluminium underscores the challenge with universal adoption of carbon pricing.

• The hope is that Europe’s CBAM could create a different type of bandwagon effect, encouraging other countries to adopt domestic carbon pricing and border taxes. Countries that export to the EU can avoid paying the CBAM by taxing carbon domestically. Canada and Australia are considering the introduction of their own CBAM and the UK has recently held a consultation on the idea.

• Reaching net zero is a herculean task of vast complexity. It will require innovation and experimentation across the economy and government policy. With carbon pricing and border taxes the ultimate prize is huge – a common way of measuring and charging for carbon across the world. If the EU’s CBAM prompts widespread adoption of effective carbon pricing it takes us a long way to that goal.

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OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 3.5% at 7,262 as investors worried interest rates would remain higher for longer due to persistent inflation.

 Economics

• UK inflation slowed to 6.8% in July from 7.9% in June due to lower energy costs but underlying price pressures remained stubbornly high
• UK wages (excluding bonuses) rose at a record annual rate of 7.8% in the three months to June, beating expectations and stoking expectations of further interest rate rises
• There were still more than one million vacancies in the UK jobs market between May and July, despite that number falling by 66,000 from the prior three months 
• The number of births in the UK fell last year to the lowest level since 2002, highlighting the country’s demographic challenge
• The volume of UK retail sales fell 1.2% in July on the previous month as cost of living pressures and poor weather suppressed consumption
• US single-family housing starts surged in July amid strong demand for homes and limited supply as existing homeowners stay put and preserve the lower mortgage rates they have locked in
• US retail sales continued to grow strongly
• US ten-year treasury yields rose close to their highest level since 2007 as markets anticipated the Federal Reserve would keep interest rates higher for longer as economic activity remained resilient
• Analysis by the US Treasury found that the Biden administration’s Inflation Reduction Act has produced new jobs mostly in areas with low levels of education and higher levels of unemployment
• The People’s Bank of China unexpectedly cut interest rates for the second time in three months as it struggles with a faltering property sector, disappointing exports and weak consumption
• The FT reports that Chinese state banks have been buying renminbi and selling dollars to slow the depreciation of the domestic currency
• China stopped reporting youth unemployment data shortly after the measure hit a record high
• The Japanese economy expanded by a strong 1.5% in the second quarter from the previous three months, driven by exports
• Data from global funds network firm Calastone shows that since 2015 UK retail investors have withdrawn billions from funds that invest exclusively in the UK while investing $50bn into global equity funds

Business

• British defence manufacturer BAE Systems agreed to buy US space technology firm Ball Aerospace in a deal worth £4.4bn, one of the largest takeovers by a UK company this year. The move underlines the growing importance of space in the defence industry
• The profitability of UK private non-financial corporates was largely unchanged in the first quarter with an average net rate of return of 9.8% – lower than the level observed before the pandemic
• Lenovo, the world’s largest personal computer maker, announced that revenues dropped by nearly a quarter in the three months to July on weaker global demand
• More than a quarter of places at English Russell Group universities went to international students, who pay higher tuition fees, last year – up from 16% between 2012 and 2017, according to the FT
• Chinese property giant Evergrande filed for bankruptcy in the US in a further sign of the deepening property crisis in China
• Accountant EY announced it is making a small number of redundancies and has warned staff to expect less generous pay awards due to a weaker economic environment
• The Italian billionaire Agnelli family acquired a 15% stake in European tech giant Philips in a €2.6bn deal
• A new policy from the UK Treasury will fine banks if they do not provide free access to cash withdrawals to individuals and businesses within one mile for those living in urban areas and three miles for people in rural areas

Global and political developments

• Russian president Vladimir Putin discussed the possibility of currency controls with policymakers following a sharp depreciation of the rouble which the central bank failed to halt despite a steep 3.5 percentage point increase in the central bank rate, according to the FT
• Donald Trump and others were charged with meddling in the 2020 presidential elections by prosecutors in Georgia, the fourth criminal case brought against the former president in recent months
• The US gave the go ahead to Denmark and Netherlands to send US-made F-16 fighter jets to Ukraine. The planes will be sent once pilot training is completed
• A German-Chinese-owned cargo ship travelled safely from Ukraine to Turkey, the first boat to travel out of Ukrainian waters since Russia’s threat that any civilian boat leaving a Ukrainian port would be considered a military target. Ukraine president Volodymyr Zelenskyy said it was an “important step towards restoring the freedom of navigation in the Black Sea”. However, a complete restoration of commercial shipping is unlikely without Russia’s agreement
• More than 300 cameras in the London’s Ultra Low Emission Zone (ULEZ) were damaged or stolen in the three months to mid-August in a further sign of how contentious the zone’s planned expansion has been
• Nicolai Tangen, chief of Norway’s $1.4tn sovereign wealth fund, said that “lately there is a much closer link between climate and inflation. That’s why it’s a proper financial risk… We have to ratchet up the work on climate”
• Former Austrian chancellor Sebastian Kurz was charged with giving false testimony to a committee investigating whether his government had been open to corruption

And finally… police in Lower Sayreville, New Jersey, reported that a widespread power cut had been caused by a fish being dropped by a bird onto a transformer at a power station – electric eel