Effective organisational management is key to manage carbon pricing risks in the face of shifting climate change regulation and government policy
Every five years, signatories to the Paris Agreement have the opportunity to revise their Nationally Determined Contributions (NDCs) to reduce greenhouse gas emissions. This year, in the lead-up to COP26, we are seeing governments set out more ambitious NDCs which are increasingly aligned to their longer-term Net-Zero commitments.
Recent announcements include revised targets by the UK and EU who have pledged to reduce their greenhouse gas emissions by 68 percent and 55 percent by 2030 respectively, compared to 1990 levels. The USA has also published their 2030 target to reduce greenhouse gas emissions by 50-52 percent compared to 2005 levels. Achieving these targets and transitioning to a low carbon economy will require significant changes to policy, the way markets operate, and technology advancement.
These fundamental shifts will change the business landscape and present both significant opportunities and enormous challenges across global supply chains. As a result, it is critical that companies have effective management systems in place to measure, monitor and respond to carbon pricing impacts on their business and supply chains as these changes unfold.
This article focuses on carbon pricing measures currently being implemented and what this could mean for your business.
Carbon prices are increasing in response to government announcements, impacting sectors with direct exposure as well as downstream supply chains
Carbon market prices are rising in response to these decarbonisation announcements. For example, the price for allowances in the EU Emissions Trading System (ETS) has reached an all-time high of more than £48/tCO2e* this year in response to strengthened EU climate targets. In addition, the UK ETS has recently started trading for the first time, opening at prices over £50/tCO2e in line with the UK’s ambitious emissions reduction plans.
Carbon prices sustained at or above this level could drive structural shifts in industry investment. For example, it is anticipated that higher carbon prices may spur the development of green hydrogen technology and related industries as opportunities in low-carbon gas are realised, ultimately with the potential to generate EUR 180-470 billion cumulative investment in Europe by 20503.
However, in the shorter-term, existing emissions-intensive sectors are calling for additional support as they struggle with high prices. Tata Steel has recently reported having placed a EUR12/tCO2e levy on steel produced in the EU and UK to cover rising carbon costs, which may threaten their long-term ability to compete with international imports1. New policy measures are being considered to protect domestic markets, encourage trade partners to decarbonise and reduce the risk of ‘carbon leakage’ to markets with lower or no carbon existing carbon pricing.
Further carbon pricing mechanisms are being considered which could impact international supply chains outside of regulated sectors
One of the most significant carbon pricing policies currently being debated is the EU CBAM (Carbon Border Adjustment Mechanism) that forms part of the European Green Deal. It is anticipated that some form of CBAM may be implemented no later than 2023, which aims to prevent ‘carbon leakage’ as the cost of EU ETS allowances rise.
Carbon leakage is the risk of consumers switching to products produced outside of regulated carbon markets, to avoid embedded carbon costs, or else businesses relocating outside of the EU to avoid carbon prices imposed directly on their production emissions. The EU CBAM aims to resolve this concern by adjusting the price of goods from selected industries imported into the EU to align to carbon costs levied on goods produced in those domestic markets.
This is particularly pertinent as the price trajectory of the EU ETS allowance is expected to continue rising to 2030, resulting in a knock-on effect to goods imported into the EU. This will significantly increase costs for sectors that produce and/or consume imported goods covered by EU ETS sectors.
The structure of the EU CBAM has not been confirmed, however, there are four options currently being considered:
- Customs duty: Tax will be applied to imports by selected sectors at the EU border.
- Excise: Tax will be applied at the point of consumption for products in relevant sectors.
- Shadow ETS: A secondary market established exclusively for imports and matches the EU ETS, but credits are not interchangeable.
- ETS obligation: Importers must purchase EU ETS allowances to cover their emissions.
Regardless of the ultimate EU CBAM structure agreed, companies who consume products covered within the scope of the CBAM could face significant additional cost pass through from existing international suppliers. Corporates should ensure that they understand the geographical composition of their emissions to enable them to undertake a supply chain review where required, make conscious cost-versus-carbon trade-offs, and ensure their pricing models are resilient to the proposed changes.
It is expected that other governments will develop and introduce ETS, CBAM, carbon taxation or similar measures to reach their carbon reduction targets over the coming years. For example, President Biden’s Plan for a Clean Energy Revolution and Environmental Justice could also result in significantly more co-ordination between carbon reduction ambitions on a global scale. Businesses must be prepared for new and developing regulations to avoid the costs associated with carbon pricing and remain competitive. With traction continuing to build as we move to a global low carbon economy, it is important to act now to be prepared for tomorrow.
How KPMG can help:
- Our market leading tool ClimateIQ can help you to assess potential carbon price exposure in key markets and sectors under different policy scenarios and explore opportunities to minimise or manage exposure.
- Our team of regulatory and carbon pricing experts can help you to understand, manage and mitigate exposure to current and incoming regulations so that you are best placed to perform in a changing environment.
*Price based on EUA futures contract expiring December 2021 and converted to GBP at £1:€1.16.