The EU Carbon Price Rally: Hurt European Competitiveness, Investor Rush

European carbon prices hit a record high of over 47 euro per tonne of emissions after the bloc agreed—albeit unofficially—to revise its emission reduction targets for 2030. A couple of weeks later, prices topped 50 euro per tonne and many expect them to continue rising.

The emission target revision was, naturally, upward: from an earlier plan to reduce 2030 emissions by 40% from 1990 levels, the EU now aims to cut emissions by 55% from 1990 levels. In the meantime, the bloc’s heavy industry is in trouble.

The Financial Times reported in April that industrial associations have doubled down on calls to Brussels to set a carbon border tax because the bloc’s emission targets and the consequent bull run in carbon prices—which are in fact the prices for permits to emit carbon dioxide—are hurting their competitiveness.

Indeed, the problem is quite easy to see. Under the European Emissions Trading System, polluters need to buy permits to pollute. These are traded like futures contracts. The price of these contracts is now soaring because of the revised emission reduction targets, which is the natural order of things.

However, goods imported into the EU are not subject to the same stringent emission standards as local production, therefore they can be sold cheaper even if their production involved the generation of more carbon dioxide. From the perspective of European industrial producers, their foreign rivals have a major advantage simply because they are not held up to the same standards European companies are.

“In the past, we did not have a significant problem with the carbon price because it was so low,” the FT quoted Axel Eggert, director-general of the European Steel Association, as saying. “Now, with the increasing price, we get into a real problem. One is our global competitors do not have those carbon constraints . . . the second point is it makes it much more difficult to invest in new technologies.”

It is clear for European companies that they would need to invest billions in carbon emission reduction technologies. They have signalled they are ready to do it, not without some substantial pressure from Brussels. But this is where the irony lies: if European steel, for example, cannot compete with Chinese steel because its price is substantially higher than that of the Chinese steel, because of carbon prices, then first, “dirty” Chinese steel will sell more and second, European steelmakers will find it hard to cut their emissions further for lack of money because of lower sales.

It’s a pretty fascinating example of a vicious circle that those tasked with the European energy transition may not have anticipated, for all its simplicity. A carbon border tax would be an equally simple solution but only on the face of it.

Carbon border taxes are a new thing, notes University of Richmond economics professor Timothy Hamilton in a recent article. No country has yet tried them nationally so their effectiveness is only hypothetical. Yet Hamilton also noted in the same article that none other than President Biden’s climate envoy John Kerry had warned the EU a carbon border tax should be a last resort.

Such a warning is interesting coming from someone whose job description suggests concern for climate change and carbon emissions. However, in an interview with the FT, Kerry noted the “serious implications for economies, and for relationships, and trade,” that such a tax would have and went on to say that “Obviously, the United States has strong feelings about not having excessive regulation.”

Naturally no country wants its goods taxed excessively as this would hurt their competitiveness. Yet just as naturally, the EU might eventually see that taxing—indirectly—its own industries to motivate their lower carbon footprints while allowing so-called carbon leakage from other countries to seep into the bloc is not what many would call fair.

University of Richmond’s Hamilton notes several studies on carbon border tax and carbon leakage, based on modelling. The evidence, it appears, is inconclusive as to the effectiveness of such a levy with regard to carbon leakage. However, common sense suggests that the tax would serve to level the field for local and foreign producers, especially in energy-intensive industries such as steel, which are particularly vulnerable to emission-related punitive actions from Brussels.

Indeed, media reported this week the EU is preparing a carbon border tax for steel, cement, and electricity imports. The new scheme will come into effect gradually, beginning in 2023, to take full effect in 2026. The U.S. has already reacted to the plan, saying it was “extremely complicated”. which most likely means “We don’t like it.” Other exporters to the EU will probably like the plan even less.

There is a growing group of people who are enjoying the carbon price rally in Europe. Investors, the Wall Street Journal reported earlier this month, are piling up into carbon funds to profit from tighter government regulation of carbon emissions and investor pressure on businesses.

I wrote earlier that the only way for the EU to make green hydrogen viable is to make each and every one of its alternatives more expensive. It seems that this same approach is being taken with regard to carbon dioxide, whether willingly or not: pollution permits will only become more expensive as their supply shrinks per EU plans and this should force industries to become greener in their energy consumption.

In the meantime, this pressure on businesses to go green is creating a whole new market for investors eager to cash in on the whole emissions crusade. This profit opportunity is the energy transition’s only real chance for success, however uncertain. This is a topic I will revisit in more detail in another post. For now, let’s just say European businesses are unhappy but investors in carbon emissions are probably hoping the EU will revise its emission reduction targets again and soon.