A plan that is being considered by the European Commission to tax the carbon emissions attributed to imported goods could create competitive advantages for foreign companies with small greenhouse gas footprints—and have financial repercussions for other exporters, adding to the financial strain caused by the COVID-19 crisis.
The tax could slash the profits that are generated by imported materials, such as crude oil, flat-rolled steel, and wood pulp, by 10% to 65%, and the tax could impact European Union and non-EU producers of such goods like chemicals and machinery, according to new research released today by Boston Consulting Group (BCG).
The study, which is described in an article titled “How an EU Carbon Border Tax Could Jolt World Trade,” found that an EU carbon tax on imports could rewrite the terms of competitive advantage in one of the world’s biggest markets. Higher prices for Russian crude oil, for example, could cause European chemical producers to import more oil from Saudi Arabia, where extraction methods leave a smaller carbon footprint. And steel that is produced in Chinese or Ukrainian mills using blast furnaces would become less competitive in the EU against steel from other countries that are made in more carbon-efficient mills.
The details and timing of the policy are still to be determined and must be approved by legislators. But the article contends that some sort of carbon-pricing mechanism is likely to be imposed on imports—and companies should prepare.
“Whatever policy is adopted, the size and strategic importance of the EU market means its action could transform the fundamentals of global advantage,” said Johan Öberg, a BCG managing director and senior partner who coauthored the article. “Companies around the world will be compelled to manage their carbon footprints with greater urgency.”
A carbon border tax is one of several mechanisms that the European Commission is considering as part of the European Green Deal, a bold initiative to cut greenhouse gas emissions in the EU by 50% over the next decade—compared with the current target of 40%—and make Europe the world’s first climate-neutral continent.
The president of the European Commission, Ursula von der Leyan, has recently called the European Green Deal a key element of the region’s post-COVID-19 economic recovery.
A carbon tax on imports also has strong support among European manufacturers. Many have been paying for carbon emissions since 2005 under the EU’s Emissions Trading System, and they have wanted a more level playing field against importers, especially those from nations with more lax environmental standards.
The BCG study assessed the impact of a potential carbon border tax on a wide variety of industrial sectors in different countries. The study assumed that the initial levy will be set at $30 per metric ton of CO2 emissions—one potential scenario.
The degree of impact on industrial sectors would be largely influenced by their carbon intensity—the relative propensity to contribute to the so-called greenhouse gas effect—and trade intensity, the degree to which goods in that sector are traded. The study also estimated the tax’s impact on the profits that are generated by exports to the EU in each sector.
Considering the effects of the tax on competitive advantage and profits, the sectors that would be hit most directly are those that produce refined petroleum products, coke (a key input in steel manufacturing), and mining and quarrying products.
The tax would reduce the profitability of crude oil shipments to the EU by about 20%, on average, for example, assuming crude oil prices remain in the range of $30 to $40 per barrel. The total profit pool generated by EU imports of wood pulp would shrink by 65%, on average.
Sectors such as basic metals, chemical products, and paper products, while less dependent on trade, would also be directly affected because of their high carbon intensity.
The tax would slash the profit pool generated by imported flat-rolled steel products, used by automotive and machinery makers and construction companies, by about 40%, on average.
In terms of commodity steel, Chinese and Ukrainian industries, which mostly produce steel using blast furnaces and basic oxygen furnaces, would be hit much harder, on average, than those of Canada and South Korea, where a greater portion of steel comes from mills using cleaner electric arc furnaces.
Because the costs of the carbon border tax would be felt far downstream in supply chains, it would impact companies in every sector, whether they are European or non-European. Owing to the size of the EU market, the tax is also likely to intensify pressure on companies and governments around the world to take stronger measures to limit emissions.
Companies in nations with their carbon-pricing schemes, such as Australia, Canada, and Japan, may be exempt if their governments negotiate new trade pacts with the EU or update existing ones.
Despite the uncertainties surrounding the price mechanisms and the timing of the policy, CEOs should start preparing now for some form of an EU carbon tax on imports. The article recommends that companies begin measuring their carbon footprints, tracking carbon pricing and its impact on their costs, building a playbook of actions to take under various scenarios, and working with governments to help shape policy.
“The best performers in each sector will not only enjoy a competitive edge in Europe,” said Marc Gilbert, a BCG managing director and senior partner who leads the firm’s work in geopolitics and trade. “They will also have a head start against less adaptable rivals in other markets as more nations embrace financial incentives to push companies to accelerate the fight against climate change.”
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