ESG Focus: Carbon Imposts Barrelling Down On Australia

ESG Focus | Mar 17 2021

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Carbon Imposts Barreling Down On Australia

The European Parliament has just backed a tax on imports that haven't priced in the cost of carbon in a move soon to be followed by the US and Britain – all this as China prepares to launch its own carbon market and FitchRatings warns of sovereign downgrades for fossil-fuel producing countries.

-EU prepares for a border tax – the pilot kicks off in 2023
-Only a matter of time before metallurgical coal is replaced by hydrogen
-FitchRatings warns of sovereign downgrades

By Sarah Mills

The European Parliament’s decision to back the European Union’s (EU) push for a carbon border tax on imports of fossil fuel products is just one of the early salvos across the bow of sovereign nations during the energy transition.

The “carbon border adjustment mechanism” (CBAM) is imposed when a low emissions technology is displaced by an imported product using high emissions technology that hasn’t priced in the equivalent cost of carbon; as set by the EU ETS market (currently about A$60/t CO2 equivalent).

The border tax applies to products such as cement, steel, energy, aluminium, refined oil, paper, glass, chemicals and fertilisers, which Credit Suisse estimates represent about 1.6% of Australia’s exports to Europe.

Credit Suisse notes that metallurgical coal for steel-making and gold are Australia’s main exports to Europe. 

But it is only a matter of time before metallurgical coal is replaced by hydrogen for steel-making; and that other materials start to replace steel (the latter being further down the pipeline; the former being as early as 2025 – only two years after the CBAM pilot scheme – although Australia is planning a shift to hydrogen exports).

The European tax is expected to be imitated by the United States and Britain in the not-too-distant future, while China is already establishing its own national carbon market.

Credit Suisse notes 3% of Australia’s exports ship to Europe; 9% to the US and UK combined; and 40% to China. 

The European Commission is expected to present the details of CBAM in June, and plans to kick off a pilot scheme by early 2023.

The move follows Fitch’s warning in February that countries set to cop the costs of stranded assets arising from fossil fuel exports could also expect to be downgraded in coming decades.

Climate change will adversely affect sovereign ratings, but intrinsic uncertainties make it challenging to robustly quantify the impact,” Fitch Ratings says on its website. 

We expect climate change to become a more important driver of rating changes as the effects become clearer, closer and more material.

Transition risks include exposure to potentially 'stranded assets' (such as fossil fuel resources that may never be used) owing to changes in global policies, technology or consumer preferences.

Countries will have varying capacities to adapt to and mitigate physical risks or diversifying economies to limit transition risks through policy changes and deploying resources and know-how.

Other risks include domestic political stability, international trade relations, heightened conflict and deep changes to institutions or economic policies. There may well be 'unknown unknowns'."

The 20 sovereign nations with the highest ratio of net fossil fuel exports-to-GDP suffered a median net downgrade of -1.6 notches from 2015-2020, Fitch noted in its report.

None of this is new. Half the world has been warning of carbon regulation and sovereign credit-rating downgrades for years.

The Australian Federal Government and multinational fossil fuel producers have known this for decades. 

Yet the Australian Federal Government has approved the Adani mine and Santos’s ((STO)) CSG operations in Western Australia and Northern NSW, regardless of significant opposition, setting up the Australian taxpayer’s liability for the impending losses.

Some investors will profit from the government’s actions, others won’t, given the very broad implications of credit downgrades on shareholdings and the economy. 

Investing in Australia is increasingly becoming a game of musical chairs. 

The CBAM, however, suggests that the music might stop a little earlier than planned.

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future: 
https://www.fnarena.com/index.php/financial-news/daily-financial-news/category/esg-focus/

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