The year 2020 will see a sharp increase in legislative measures to accelerate the transition to a low carbon economy. The European Green Deal is a prime example of this legislative effort.
The year 2020 will see a sharp increase in legislative measures to accelerate the transition to a low carbon economy. The European Green Deal is a prime example of this legislative effort. Through this green policy, Mrs von der Leyen’s Commission’s stance on sustainable finances and climate commitment will be as – if not more – ambitious than her predecessor’s. For now, the new initiatives remain fairly broad and require some fine-tuning. Still, we can already clearly discern the major outlines of this policy, which seeks to achieve EU carbon neutrality by 2050.
Firstly, the green deal will set up an effective carbon-pricing and a carbon-border adjustment mechanism in 2021. In the past, EU regulators have strongly prioritised the reduction of carbon emissions in power generation, transport and industry. However, they largely ignored the emissions associated with the manufacturing and transport of products from abroad. Still, the continued increase of carbon emissions clearly reflects the need for an effective carbon pricing scheme. The carbon-pricing scheme would enforce payment to compensate for both domestic emissions as well as pollution caused by imported products.
Source: OECD Environment at a Glance Digital Platform
Total CO2 emissions compared to total carbon footprint of OECD Member States (incl. imported emissions)
Source: OECD Environment at a Glance Digital Platform
Next, the Commission will propose the first-ever European Climate Law in March to achieve climate neutrality by 2050.
In addition, it will also set more aggressive 2030 decarbonisation goals. Previous targets aimed for a 40% decrease in carbon emissions compared to the levels observed in 1990. The Green Deal will revise these targets upwards to a decrease of at least 50-55%. In order to update these objectives, there will be a revision of the EU’s climate-related policies in June 2021. The Commission is also envisaging an option to extend the current European Trading Schemes (ETS) to new sectors. The road and maritime transport sectors, as well as the building sector and the agricultural sector are being considered for inclusion. The current sectors covered by the ETS are power and heat generation, oil refineries, steel works as well as the production of iron, aluminium, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids, bulk organic chemicals and commercial aviation.
The deal also aims to promote a circular economy through different projects, such as decarbonisation technologies, transport as well as a focus on buildings and their renovation rate. In addition, the European Green Deal wants to set up a so-called “Farm to Fork” strategy to create a global standard of sustainability in the agri-food sector.
Although the European Commission’s ambitious plan is still lacking some concrete details, it is expected to substantially impact the economy in the next five years. The Green Deal has also brought back two key, interconnected concepts which will become increasingly relevant in the near future: carbon leakage and carbon border adjustment.
Carbon leakage is the risk that businesses move their production abroad to avoid the relative cost of carbon pricing schemes. The European Commission has tried to reduce this risk for high-emitting sectors which are globally mobile by granting them a higher share of free allowances. As a result, this has led to a reduction in incentives to invest in low-carbon technologies. Therefore, through the next phase of the EU ETS from 2021 to 2030, the European Commission will be trying to achieve higher climate ambitions by reducing the global allowances on the one hand, while extending these allowances on the other hand for the sectors most at risk of leakages.
As of today, the World Bank recognises 51 different carbon pricing schemes across the world. Unfortunately, the failure of the latest Conference of the Parties (COP) to agree on unified carbon pricing mechanisms clearly showcases that a single carbon pricing arrangement is a utopian concept. Consequently, some countries/regions could apply stricter carbon-pricing schemes than others. This difference engenders a risk of leakage. As a response, 3500 economists (among whom Nobel prize winners and ex-FED chairmen/women) have recently issued “the Economists’ Statement on Carbon Dividends”. The core idea of the proposal calls for a domestic carbon tax, which is mirrored by a green border tax, with a view to avoid a loss of competitiveness. The domestic carbon tax will attempt to incentivise the financing of low carbon technologies, while the green border tax will try to equate the regulatory regime of domestically produced goods to that of imported products.
This green border tax would mainly be a temporary measure which would cease to exist once low carbon technologies have been (nearly) fully adopted. Renewables followed a similar path in the past: after relying on subsidies for several years, they eventually managed to sustain their own growth without needing any financial crutch.
Over the last months, the social unrest in France has shown how eco-based taxes can trigger socio-political discontent. This example illustrates how important it is to neutralise the punitive impact of Green taxes. This is the view taken by The Economists, which calls on governments to return the money collected through environmental taxes to its citizens. For example, the Canadian province of British Columbia previously introduced an inflated carbon tax which raised the cost of gasoline and energy. However, income from this tax was largely returned to the local population in the form of various tax cuts.
Analysts and portfolio managers will have to closely monitor the Green Deal and its implications to update the valuations of the relevant businesses and companies accordingly. With the help of the TCFD recommendations -of which DPAM has been supporter since 2018- our investment teams will integrate these in an active and research-driven way to ensure sustainable returns.