Climate change & decarbonisation Climate change & decarbonisation Climate change & decarbonisation

As we enter into an era where budgetary policy will increasingly focus on the climate agenda, it is important to understand some of the wider hot topics on the climate agenda which overtime will feature as part of Government policy on climate.  Mike Hayes and Shane O'Reilly of our Sustainable Futures team elaborate below.

At the beginning of November this year, the COP26 event, convened by United Nations Framework Convention of Climate Change (UNFCCC) will take place in Glasgow Scotland. COP26 is a global United Nations Summit about climate change and how countries are planning to tackle it. The UK, together with its partner Italy, will host this conference that many believe to be the world’s best last chance to get runaway climate change under control. COP26 will be attended by countries that singed the UNFCCC – a treaty agreed to in 1994: in addition, business leaders and other influential leaders on the climate agenda will participate in this event.

This event is going to result in an even greater focus on climate action by Governments around the world including the Irish Government. It is expected that there will be a number of significant announcements of new initiatives at COP26 and it will be important for Irish business to digest the full ramifications of these announcements is due course.

Turning to some of the so-called hot topics, some of which will feature at COP26:

One of the greatest challenges in confronting the climate challenge is moving from the era of net-zero commitments to actually delivering on those commitments. This is going to be a major challenge for countries and global corporations who have made these types of commitments, as it is clear that all of the solutions to achieve net-zero are not yet available. This is why the area of climate innovation is starting to come to the forefront as it is recognised globally that much more work needs to be done to reduce the costs of some of the important nascent technologies such as direct air capture, green hydrogen, sustainable aviation fuels etc. and also to find ways of supporting new innovation which will develop new solutions for this important agenda.

At COP26, two very significant initiatives will be announced to support the acceleration of climate innovation:

This is an initiative developed by US Special Climate Envoy, John Kerry, and is designed to find solutions to commercialise innovative technologies so they are available for massive scale up to enable net-zero emissions by 2050. The initiative involves gathering some of the largest companies around the world to send market demand signals for these essential technologies. The idea is that the purchasing power of these global corporations can be used to reduce costs over time and help scale these technologies.

One of the significant challenges in climate innovation is the lack of support for the eco-system of independent climate developers which have sprung up in recent years. The challenge is not just the lack of funding but also finding large scale industrial partners in order to trial the type of innovations which are required. In addition, many of these innovators do not have access to scientific or academic expertise.

At COP26, UNFCCC will be announcing an initiative designed to deal with these systemic issues. The proposal is to create a digital platform called the Global Innovation Hub which will host not just the innovators but also other key stakeholders including financial investors, large corporations in specific sectors and a range of academic and scientific experts. It will enable much greater ease of access between all of these stakeholders. A key area of focus for the Hub will be to determine the critical areas where new innovation is required.

I see all of this as being very relevant to Ireland as it is clear that Ireland has a thriving sub sector of climate innovators working in areas such as new forms of renewable energy, hydrogen and carbon capture, among others. Most of these are smaller independent individuals and companies who are facing all of the problems identified above. Both of these initiatives will offer an opportunity to  these Irish innovators to commercialise and scale their innovations.

Globally, as Governments and regulators begin to focus on the seriousness of the climate threat, the use of fiscal and non-fiscal policy measures is increasingly coming to the fore. The reality is that for hundreds of years, Governments have used fiscal policy to change behaviours in society and this is very true on the climate agenda. Below we look at the position both locally and at an EU level where a number of significant measures will have emerged, but with much more to come.

The Climate Action and Low Carbon Development (Amendment) Bill 2021 introduced in the lead up to Budget 2020 set Ireland on a legally binding path to climate neutrality by 2050.  The main focus of the Bill sees Ireland becoming a climate neutral economy no later than 2050.  One of the key mechanisms for securing a climate neutral economy is the introduction of a series of economy wide 5-year carbon budgets with sectoral emission ceilings for each relevant sector.  A key milestone in this programme is 2030 whereby the first two carbon budgets should deliver emissions savings of 51% in line with the Programme for Government released in 2020. These ambitious emissions reductions are aligned to overall EU ambitions.

On 14 July, the European Commission (EC) passed a crucial milestone by adopting the EU “Fit for 55” package to transform the European economy.  The package of interconnected legislative proposals will align the EU's climate, energy, land use, transport, and taxation policies with the target of reducing net greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels.

This commitment is part of the EU Green Deal, which is a comprehensive package of tax and non-tax measures aimed at developing a growth strategy where there are no net emissions of greenhouse gases in 2050 and where economic growth is decoupled from resource use.  Within its toolkit the EU is proposing several tax and carbon price reforms as part of the Green Deal, namely:

• Extension of the Emissions Trading System (ETS), including possible phasing out of existing free permit allocations for many participants.
• Introduction of the Carbon Border Adjustment Mechanism (CBAM).
• Reform of the Energy Taxation Directive (ETD).

The EU ETS puts a price on carbon and lowers the cap on emissions from certain economic sectors every year. Over the past 16+ years it has reduced emissions from power generation and energy-intensive industries by c.43%. The EC is proposing to lower the overall emission cap even further, increase annual rates of reduction and phase out free emission allowances for aviation. A new separate emissions trading system to address the lack of emissions reductions in road transport and buildings is also proposed.

With the ETS carbon price above €60 per tonne as of October 2021, this mechanism now has material economic implications for corporates and has the potential to influence corporate decision making.

Increasing ambitions for emissions reduction raises concerns about potential “carbon leakage”. This is the concern that consumers / producers in the EU with higher emissions ambition will be encouraged to purchase imports or move operations to low ambition regions where the cost of production is lower.

In order to address risks of carbon leakage from these developments, the EC released a consultation process in 2020 on the design features of alternative approaches to introducing a CBAM. This could take a number of forms, including:

• A tax on imports (a Carbon Border Tax imposed through the tariffs).
• Importers being incorporated within the existing ETS.
• A mechanism based on the ETS but involving a separate system for importers; or
• A new (excise-style) tax charged both within the EU and on imports, based on the average carbon intensity of certain products (sometimes referred to as a Carbon Excise Tax).

At this preliminary stage, it is understood that the products proposed to be covered in the first instance will include aluminium, steel, cement, glass, paper, and heavy chemicals. The precise form which the proposed CBAM will take will only become clear once the EC tables draft legislation in the form of a proposed directive.  

The existing ETD is close to 20 years old and does not reflect the current developments in green energy.  The reformed ETD has several ambitions; to address harmful effects of energy tax competition; securing revenues for Member States from green taxes; removing outdated exemptions and incentives of fossil fuels usage and promoting investment in new and innovative green industry.

To achieve these ambitions, the EC is proposing a new structure of tax rates based on the energy content (expressed in EUR/GJ, e.g. gas oil & petroleum at €10.75/GJ, renewable Hydrogen at €0.15/GJ) and broadening of the taxable base by adding products and removing exemptions such as with aviation and shipping fuels.  The ETD proposal suggests minimum rates of taxation that encourage a switch to more sustainable fuels while reflecting the extent to which they are at risk of carbon leakage.  There is also a 5-year review period to keep the ETD up to date.

As the new ETD is a revision of an existing directive, its unanimous acceptance by all members of the EU Council is required. Provided unanimity is achieved, the ETD should come into force in January 2023.

Companies that procure or consume products covered within the scope of the EU ETS, e.g. manufacturing, could face significant additional cost pass-through from existing suppliers if the CBAM is implemented, due to the significant emissions occurring in geographies without commensurate low carbon policies and the emissions associated with transport of the goods to the EU. Corporates should ensure that they understand the geographical composition of their emissions to enable them to undertake a supply chain review, where required, making conscious cost versus carbon trade-offs and ensuring the resilience of their pricing model to the proposed changes.

The EC measures above are part of a programme of interventions, with individual components categorised as “pricing”, “targets” or “rules”; that will operate together to achieve its objectives.  These undertakings are a proactive approach to using tax policy as an instrument to fight climate change, a potential feature of the EU landscape for many years to come.

Much of the narrative on climate focuses on the need for policy action, mobilisation of capital and accelerating innovation. However, we believe there is a fourth dimension that now needs to be recognised and that is the people factor.

In other words, all these global corporations who are making net-zero commitments will not achieve their goals without taking into account the people and human capital factor. The reality is that there is a significant number of human capital issues to be considered including the following:

• Appointing expertise at board level
• Incentivisation of management to achieve climate goals and increasingly linking incentives to carbon reduction performance
• Reskilling and retraining employees given the strong possibilities that companies will need to provide different types of goods and services in a greener future. This is a going to be most relevant in a number of existing high carbon industries
• Lack of sufficient expertise to deliver on decarbonisation strategies
• Last but by no means least, the concept of “stranded” people. It is recognised that some employees will not be able to adjust to a new low carbon world for a number of different reasons and may well face an uncertain future.

For all of these reasons, there is a role for Governments including the Irish Government and educational establishments, particularly third level institutions. In future, there needs to be much greater focus on both the educational aspects in the sense that the climate industry needs many more new graduates who can focus on the diverse range of skills that are required. However, it is likely that Government support will be needed to engage in wholesale retaining and reskilling in particular to avoid the spectre of stranded people. 

The reality is that Governments will need to play a much greater interventionist role on climate between now and 2050 – not just in relation to specific taxation areas such as carbon tax but they will also need to work with industry and society at large to tackle some of the key issues on the agenda which we have described in this article. The message is very clear – the climate agenda will form part of our daily lives for many years to come there will be a substantial readjustment required for all of us. 

This article originally appeared in the Business Post Budget 2022 magazine in association with KPMG, and is reproduced here with their kind permission.

The pace of change is challenging leaders like never before. To find out more about how KPMG perspectives and fresh thinking can help you focus on what’s next for your business or organisation, please get in touch with Mike Hayes or Shane O'Reilly of our Sustainable Futures team. We’d be delighted to hear from you.