Allianz research highlights challenges of creating level playing field without global carbon tax, suggests uncertainties for investors in heavy-emitting industries.
The European Commission’s long-anticipated proposal for an EU carbon border adjustment mechanism (CBAM), released this week as part of its ‘Fit for 55%’ climate action strategy, could have unintended and potentially counterproductive consequences, according to Allianz.
A research note from the German financial services group says the proposed scheme is well-intentioned, but not necessarily “well-done”, arguing it would not result in a level playing field for firms operating in sectors heavily exposed to carbon pricing and could present “an invitation for greenwashing” if implemented as currently drafted.
Despite the inclusion of several measures to reduce the likelihood of sudden shocks to affected carbon-intensive industries – iron and steel, cement, fertilisers, aluminium and electricity generation – uncertainties around the new mechanism could impact investors’ appetite for long-term exposures.
The CBAM imposes a carbon price on imports of typically carbon-intensive products, by means of certificates purchased by importers, in order to guarantee EU emissions reductions contribute to a global decline. The aim is to ensure that the decarbonisation of industrial processes in Europe does not lead to leakage of emissions in non-EU countries, either via imported goods or relocation of production facilities.
A similar effect is currently achieved by issuing free allowances under the EU Emissions Trading Scheme (ETS) to certain industries, but this is regarded as providing insufficient incentives for firms to invest in sustainable, low-carbon processes, both within and beyond the EU.
Starting with a limited number of products, the CBAM is intended to ensure that both domestic and imported products pay the same carbon price, in line with World Trade Organisation (WTO) rules. Firms in targeted sectors will be incentivised to innovate to reduce emissions through the gradual phasing in of the CBAM and the phasing out of allowances.
But Allianz says it will be too easy for non-EU firms to get around the proposed rules. Because a non-EU company is allowed to use an individual assessment of its emissions, rather than EU-provided default emission intensities, it may be able to claim that all the electricity it uses to manufacture goods for export to Europe is from renewable sources.
According to Allianz, this can be achieved via ‘power purchase agreements’, potentially enabling firms to then apply for a deduction from their EU carbon certificates. “The result is then merely the reallocation of existing renewable electricity to products imported into the EU, using the remaining brown electricity to produce goods for non-EU markets,” the research explains.
“Within the EU, producers don’t have the option to use this set-up to evade carbon pricing obligations for products they sell outside of the EU, unless they relocate their production for non-EU customers outside of the EU.”
The CBAM is scheduled to be introduced from 2023, when a reporting system will apply for the initial group of products, with importers paying a financial adjustment from 2026. From this point, free ETS allowances will be gradually phased-out until 2035.
Allianz also says the proposed CBAM framework risks shifting “competitiveness and carbon leakage issues just one step down the value chain” due to the EC’s desire to maintain compliance with WTO rules. By temporarily maintaining free allocation of EU ETS certificates, the Commission’s approach gives it limited scope to reform the ETS toward a level playing field, says Allianz, and excludes use of carbon levy reimbursements for exports.
“If higher carbon-related costs are passed on, e.g. from steel makers to EU car manufacturers, the car manufacturers in turn might choose to relocate part of their production outside the EU in order to gain access to cheaper steel for their non-EU automobile customers,” it added.