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ESG Focus: Europe’s Getting ‘Fit for 55’

ESG Focus | Aug 18 2021

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:

Europe’s Getting ‘Fit for 55’

In a post-pandemic Europe, climate change is front and centre of political agendas across the continent. The EC has proposed necessary changes to enact in the next decade to reach previously agreed to climate change goals.

-‘Fit for 55’ policy package is a proposed pathway for EU members to achieve a -55% reduction in greenhouse gas emissions by 2030
-The policy package is an initial step towards achieving net zero emissions by 2050
-Proposals include expansion of the emissions trading scheme and the introduction of carbon tariffs
-The EU estimates it will spend EUR503bn on its climate change agenda in the next decade

By Danielle Austin

Amidst a number of climate change related extreme weather events, including severe flooding in Germany, Belgium, the Netherlands and Italy, wildfires in Spain, France, Finland and Greece and the rapid melting of ice in Greenland, the European Commission (EC) has identified an increasing urgency to address emission reductions.

The EC has released its ‘Fit for 55’ policy package, outlining suggested policies for the European Union’s (EU) 27 member states to enact to achieve a reduction of net greenhouse gas emissions of -55% compared to 1990 emissions by the end of the decade.

This proposes a significant emissions reduction target increase from the current -40% in the same time frame, and could drive the EU to becoming a global leader in the carbon emission reductions race.

The proposal includes expansions to the current emissions trading scheme and the introduction of a carbon tariff. Additionally, the EC is proposing targeted use of renewable energy needs to be increased to 40% by 2030 from the current target of 32%, and the phasing out of petrol and diesel vehicles by 2035. Analysts note emissions reforms are likely to put long-term upward pressure on carbon prices.

The proposals are dependent on approval from member states and the European parliament, a process which could take months and may see amendments made to the policy package. Bringing proposals into legislation is a process that could take as long as two years.

Impact of CBAM on Australian exports

Of particular note in the ‘Fit for 55’ policy package is the introduction of a carbon border adjustment mechanism to take full effect from 2026.

The mechanism is aimed at evening the playing field for offshore producers who aren’t required to follow the same stringent emission policies as domestic players, and discourage high-emission industries from relocating offshore to avoid carbon costs.

The goal of the Carbon Border Adjustment Mechanism (CBAM) is to reduce carbon leakage, the term given to the displacement of locally-low-carbon-produced products by imported products produced using higher emission technology where emissions have not been correctly priced.

Under the mechanism, EU importers will be required to purchase carbon certificates that correspond to the carbon price that would have been paid had the goods been produced under the EU’s carbon pricing structure. Where importers can prove carbon pricing has already been paid during production the price can be deducted.

According to the EC’s policy package, the CBAM will initially only be applied to direct emissions. However, tariffs on embedded emissions will be applied to imported goods from 2026, allowing for a transitional reporting period on embedded emissions from 2023.

The initial products to be included in the CBAM are aluminium, iron ore, steel, cement, fertilisers and electricity, which to Europe represent only 3.5% of Australia’s total exports.

According to Macquarie analysts, while the EC’s proposed carbon tariffs won’t initially have substantial impact on Australian exports, the list of goods covered by the mechanism is likely to expand over time.

A successfully implemented tariff by the EU may also see similar mechanisms adopted by other countries, with the US, UK, Japan and Canada already reportedly considering border tariffs.

Expansion of the Emissions Trading Scheme and a united approach

The EU’s existing Emissions Trading Scheme (ETS) has been the key driver of reduced emissions in the EU since 2005 and is set to be expanded under the EC’s proposal.

The policy package suggests an extension of the ETS to include aviation and shipping, as well as introducing steeper increases to annual emissions cap reductions and the implementation of an additional emissions trading scheme for the building and road transport sectors.

This new ETS, set to come into play in 2026, would aim to regulate fuel suppliers rather than consumers. While analysts note it is not yet clear who the responsibility for this scheme would fall on, if refineries were responsible it would likely lead to increased fuel prices to offset the necessary purchase of additional carbon credits.

The proposed policy is underpinned by a united approach by all EU member states to achieve a common goal, and the proposed updates to the existing ETS include the introduction of an effort sharing regulation which would see larger emission reduction targets handed out to member states based on per capita gross domestic product.

Further to this, the EC has proposed the creation of an integrated green employment framework to support labour market shifts in a greener economy.

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