The material scenario of potential carbon border taxes
Interest is growing in the idea of carbon border taxes. Indeed, the possibility of such a carbon tax on imported goods is more and more discussed, particularly in Europe.
It is noteworthy, for example, that the EU’s largest business lobby group (BusinessEurope) recently considered carbon border adjustments as a possible option to be assessed as “additional safeguards depending on international actions”[1], thus dropping a long-standing opposition[2] to this idea. And we can also remember the position explicitly expressed by steel mogul Lakshmi Mittal in 2017[3] in favour of a carbon border tax.
Some countries also support carbon border tariffs. The idea is not new and in the past France and Italy already supported it in the public debate. It is true that in the last 10 years, some countries have also expressed hesitation or concerns regarding impacts on their exports, but the question remains discussed at high-level. For example, French President Emmanuel Macron[4] has already supported several times the idea, and recently Spain[5] also expressed official support to such a scheme. In France, it can even be noted that most parties[6] agree on this. In this context, we cannot escape taking into consideration a scenario in which international trade prices could be readjusted by carbon intensities.
The idea has also widened its support from economists. Last January, more than 3 500 of them in the U.S.[7] (including 27 Nobel laureates, 4 former Chairs of the Federal Reserve, and 2 former Treasury Secretaries) backed carbon tariffs on key imports. This was followed by a similar call by European economists[8] in June 2019, and the subject is now an area of academic research, for example, to address the challenges[9] linked to the design of border adjustments: e.g. technical feasibility, data availability, risk of retaliation from some countries, compatibility with World Trade Organization rules, etc. Now, the question is essentially political even if there are of course issues to be aware of.
The implementation of carbon border adjustments in one or several of the world’s regions remains uncertain – and there would be uncertainties in the precise conditions of its implementation –, but the impacts would be significant so that macro-financial and sovereign analysis should closely consider such scenarios.
To this end, our data provide useful resources for investors to assess what could be the impacts of carbon border adjustments on trade flows, whether looking at the competitiveness of exports or the carbon intensity of imports. We are for example able to model carbon intensities of traded goods and services for each country, sector and country-sector segment, based on 26 sectors. This allows us, for instance, to assess what is the carbon intensity of exports of the United Kingdom, or what is the carbon intensity of its imports from China, Germany or the USA (overall and for a given sector).
MATERIAL ISSUES FOR INVESTORS IN SOVEREIGN AND CORPORATE ASSETS
In this context, some countries can be at a disadvantage regarding their exports because of carbon-intensive energy mixes, the poor energy efficiency of their industrial systems, a focus on high carbon-intensity production, or a particularly strong reliance on high-carbon exports.
It is therefore of interest for investors to be able to position countries based on both the weight of exports in their economies and the greenhouse gas emissions (GHG) intensity of their exports, as described below.
Figure 1: GHG content of exports and exports/GDP % for the top 20 countries (81% of world GDP)
Figure 2: GHG content of exports and exports/GDP % for the top 100 countries (98% of world GDP)
This analysis is material for sovereign investors – as an area of potential reshuffling of cards in the global economy –, but it is also obviously material for the long-term financial analysis of corporates, in particular in some concentrated and carbon-intensive sectors being significantly exposed to exports (e.g. steel, other materials, capital goods, automotive, etc.). In this context, such analysis should also be conducted at the sector level as well as by taking into account the specificities of companies’ positions.
In fact, both for companies and countries the analysis of the carbon intensity of traded goods and services should be a starting point rather than the only metric by which to assess risk and opportunity levels. It is certain that carbon border adjustments would also result in some trade and industrial “adjustments”. This is indeed the goal that such policies would target: favouring the development of less carbon-intensive economic production.
However, other factors would drive country-, sector- and company-specific impacts. This includes, for example, the pricing power of exporting countries and price-elasticity of demand for their products. In addition, carbon border taxes would also impact countries through their imports (see appendices). For example, for importing countries, a notable factor can be their capacity (or not) to use, develop or find alternatives.
Lastly, it should be noted that the carbon intensity does not fully reflect risks associated with fossil fuels exports. Of course, fossil fuel exports can be relatively carbon-intensive because of production emissions, but most emissions related to fossil energy occur in the importing country. This is also something to look at when assessing the international impacts that would result from a deeper integration of climate considerations into international trade.
To put it simply, the development of carbon border tariffs is a scenario to consider in the fundamental analysis of sovereign and corporate assets. It is, of course, uncertain (as illustrated for example by the recent trade deal between the EU and Mercosur[10]), but it deserves attention as its impacts could be significant for investors. If climate issues are more integrated in trade in the future, there will unavoidably be losers and winners. Such changes could be more or less progressive or non-linear, strong or moderate, but they would be meaningful.
APPENDICES
Figure 3: GHG content of imports and imports/GDP % for the top 20 countries (81% of world GDP)
Note: Top countries by GDP size in 2018; excluding non-available and extreme values
References: Beyond Ratings, PRIMAP-hist, Eora, IMF, World Bank.
Figure 4: GHG content of imports and imports/GDP % for the top 100 countries (98% of world GDP)
Note: Top countries by GDP size in 2018; excluding non-available and extreme values
References: Beyond Ratings, PRIMAP-hist, Eora, IMF, World Bank.
Guillaume Emin, Carbon/Climate Analyst
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[1] BusinessEurope. (2019). European business views on a competitive energy & climate strategy.
[2] Simon, F. (2019). BusinessEurope warms to Macron’s EU carbon tariff idea, EURACTIV.
[3] Mittal, L. (2017). A carbon border tax is the best answer on climate change, Financial Times.
[4] Simon, F. (2018). France to push for EU carbon price floor and border tariff, EURACTIV.
[5] Reuters. (2019). Spain proposes EU carbon tax on energy imports, Reuters.
[6] Barbière, C. (2019). Most French parties agree on carbon tax at EU’s borders, EURACTIV.
[7] Turner, A. (2019). The Case for Carbon Tariffs, Project Syndicate.
[8] Strauss, D. (2019). EU economists call for carbon taxes to hit earlier net zero goal, Financial Times.
[9] Rocchi, P.; Serrano, M.; Roca, J.; Arto, I. (2017). Border Carbon Adjustments Based on Avoided Emissions: Addressing the Challenge of Its Design, Elsevier.
[10] Brunsden, J. (2019). EU and South American bloc reach trade deal to cut tariffs, Financial Times.